DODO: A Revolution in On-Chain Liquidity

Aug 14, 2020 · 6 min read

On-chain liquidity is to DeFi what oil was to the Industrial Revolution.

From Bancor to Uniswap to Curve, automated market makers (AMMs) have transformed the world of decentralized finance, but they are merely a stepping stone: these algorithms are too primitive and static to work in the long run. They do not respond intelligently to market changes or employ proactive trading strategies like human market makers.

This is why we built DODO, a next-generation algorithmic market maker capable of responding to changing markets and liquidity constraints in real-time. Before I explain how DODO works, I must first explain why it was necessary for us to build it.

Order Book DEXes Don’t Work

I have been working in the DEX space since 2017, and I am fully convinced that order book DEXs are fundamentally unsuited for the blockchain world today. Their flaws are twofold: they cannot share their liquidity with other DeFi protocols, and they fail to take advantage of the overall growth in DeFi liquidity, due to the lack of composability.

What’s more, order book DEXs are at the mercy of centralized exchanges (CEXs). As soon as these DEXs lose access to the APIs provided by CEXs, their liquidity structure collapses.

As a result, order book-based DEXs get the worst of both worlds — their operational costs are barely lower than CEXs, yet they ultimately cannot compete with CEXs in terms of liquidity.

Algorithmic Liquidity: The Blockchain-Native Approach

Putting the financial system on the blockchain means that we have to change the way we think about everything. We now live in a world where the most atomic unit of time is a singular block. It’s only natural that we design products with that as our guiding principle.

The advent of the constant product pricing formula x*y=k was a perfect example of that kind of thinking.

This simple AMM algorithm achieved something absolutely remarkable: it automated trading and eliminated the need for the order book altogether. Thanks to this automation, AMM DEXs, such as Uniswap, Balancer, and Curve, all enjoyed explosive growth upon their releases.

AMMs are “Lazy” Algorithms

Although the AMM was a massive innovation in the DEX space, it is most definitely not a silver bullet. Its biggest flaw is the fact that it allocates funds uniformly across the price range (0, +∞). This means that only funds allocated near the market price are being utilized effectively in trades, with the vast majority of funds underutilized or not utilized at all. That is, most of the inventory of the market maker is sitting around doing nothing, waiting in the wings in case the pool becomes extremely imbalanced.

As a result, constant product AMMs suffer from low fund utilization and high slippage. On the other hand, human market makers outperform AMMs still, because they are capable of constantly identifying inefficiencies in the market and removing them to the best of their abilities. This is the reason why on-chain liquidity for mainstream crypto assets on AMM DEXs are nowhere near the level of CEXs.

The million-dollar question now is: is it possible to emulate an intelligent, “hard-working” on-chain market maker using algorithmic means?

Proactive Market Maker (PMM): Next-Generation On-Chain Liquidity Solution

Proactive Market Maker (PMM) provides the answer. The following product pricing formula is the heart of PMM:

(where i is themarket price and R is the risk factor)

PMM leverages price oracles, mimics the behaviors of human market makers, and efficiently allocates funds near the market price. This translates to a high level of liquidity on par with CEXs. I will further illustrate this point with the following graphs.

With everything else fixed, it is clear that the DODO curve is significantly flatter than the Uniswap curve near the market price, indicating higher fund utilization and lower slippage.

As the market price changes, PMM, as its name implies, proactively shifts the price curve in the same direction to ensure that the section in the vicinity of the market price remains flat. This ensures the constant provision of sufficient liquidity.

In addition, PMM adopts a risk-neutral approach by decoupling the base and quote tokens in any trading pair. There is no need for liquidity providers (LPs) to deposit both tokens of the desired trading pair proportional to the current price. Instead, LPs deposit only the tokens they have, and nothing more.

When a trade takes place, PMM dynamically adjusts the price by encouraging arbitrage trading in order to minimize price risks and counterparty risks for LPs. This mitigates the notorious issue of impermanent loss inherent to AMMs.

For a more comprehensive explanation of the PMM algorithm, please refer to our Medium article here.

Introducing DODO, an On-Chain Liquidity Provider Powered by PMM

Based on the PMM algorithm, we created DODO, a decentralized platform for trading and issuing crypto assets.

What Can I do with DODO as a Trader

Each and every trader enjoys liquidity similar to that of centralized exchanges
Arbitrageurs can profit from the price discrepancies between DODO and other exchanges
Smart contracts can natively use DODO liquidity to complete on-chain transactions, such as liquidation and auctions

What Can I do with DODO as a Liquidity Provider

There are no minimal deposit requirements and restrictions on asset types
DODO charges a fee for each transaction and eventually distributes it to LPs as rewards
LPs can create trading pairs with their own tokens
LPs can obtain liquidity by depositing their tokens they already own, without taking on price risk

Early Bird Campaign (Starting August 15, 2020)

DODO is not live yet, but we will be pre-launching in an early bird campaign on August 15, 2020. The rationale behind this campaign is to encourage liquidity providers (LPs) to become early adopters of the DODO platform, by offering exclusive rewards to invitees.

Only the ETH/USDC trading pair will be available, and a US$1 million token pool has been allocated for both ETH and USDC. Allocation of quotas will only be provided to invitees who already have a solid understanding of DODO. Token deposits will halt once the pool limits have been reached.

Investment return for LPs is paid out from transaction fees, charged for every trade at 0.3%. According to our backtests, when the DODO total reserve is at one-tenth (1/10) of Uniswap’s level, DODO can provide an impressive 80% APR in return.

That said, market making is not a risk-free undertaking — LPs have to accept price risks due to market fluctuations and smart contract risks. DODO was audited by Peckshield, Inc. and the audit report can be accessed here.

Please rest assured that token withdrawals will always be available and you may withdraw your tokens at any time.

We look forward to welcoming traders to the next generation of algorithmic market making on August 15, 2020. Once the early bird campaign is over, DODO will be accessible to all LPs.

Join the on-chain liquidity revolution with DODO!