I was watching a video on YouTube by Chico Crypto and he posted a chart that blew my mind. This is the chart of all wealth worldwide and in what assets it's held in.
You've probably seen it before but it was recently updated to take into account the recent QE bonanza.
Have a look here as it's too big to post: All the World's Money & Markets
Here are a couple notable facts:
The FED's balance sheet sits at over $7 Trillion and over 40% of this was added in 2020 alone because of the pandemic.
The world's 2,095 billionaires have $8 Trillion in assets which is more than all tangible currency - coins and banknotes - in circulation worldwide ($6.6 Trillion)
Annual global military spending is 7x more than all cryptocurrency in circulation ($1.7 Trillion vs $244 Billion) with Bitcoin being 2/3rd of that amount.
Physical cash is only 7% of all narrow money - easily accessible money - and only 2.5% of broad money. All money created today is already digital.
The biggest item is derivatives which are anywhere between $585 Trillion and $1 QUADRILLION in notional value.
Here's what I see:
Imminent Failure: To me, these numbers don't make sense and can't last. Every year, you need to add more debt to keep up the "Big Lie" - it's exponential and eventually fails.
Inequality: The wealth inequality is staggering and the misallocation of resources is levelling on the absurd. How do we spend so much on the military yet cannot even feed and take care of people.
Opportunity: There are mountains of inefficiencies trapped in assets, derivatives, etc. waiting to be tapped and unleashed - it'll happen with crypto.
Also, this week I read a fantastic article on automated market makers, the subject of today's post, which has made me think Ethereum may be setting up to replace a lot of our economic system.
In this post, I want to explore how you can earn money by providing liquidity to decentralized exchanges but more importantly I want to examine the implications for how we store wealth.
But first let's do a quick recap.
Recap
I started this series introducing you to Bitcoin and the value of scarcity in our lives.
From there I provided ways to value one Bitcoin before giving guidance on how to buy your first stablecoin and trade it on a decentralized exchange or DEX.
In my last two posts, we first learnt how to dollar cost average into Bitcoin before starting to explore ways to earn crypto - the first being through passive interest earned on lending platforms.
Use the links below to jump back in...
The Origins of Wall Street
Wall Street has its origins in, like many things in our world - exploitation and specifically the slave trade. In 1711, New York named Wall Street the location of the city's slave market.
Given the large role slavery played in the early economics of the American colonies - it quickly become the financial center of the young city. Yet it was a local buttonwood tree at 68 Wall Street that gave birth to the financial capital of the world you see today.
Here traders signed the Buttonwood Agreement - a two sentence document that reads as follows:
We the Subscribers, Brokers for the Purchase and Sale of the Public Stock, do hereby solemnly promise and pledge ourselves to each other, that we will not buy or sell from this day for any person whatsoever, any kind of Public Stock, at a less rate than one quarter percent Commission on the Specie value and that we will give preference to each other in our Negotiations. In Testimony whereof we have set our hands this 17th day of May at New York, 1792.
Two important things to notes:
Closed System: It was fundamentally a closed system which continues to this day as its only accessible by registered brokers. This closed system could be captured by insiders.
Commission: It specifically set out a commission rate of 0.25% which would be provided to insiders for bringing liquidity to the platform thereby incentivizing continued growth.
Both points will become salient as we explore our new system.
What are order books?
From this agreement was birthed the New York Stock and Exchange Board (later known as the NYSE). Fast forward to the late 1920's and a new technology, the telegraph, is created by Samuel Morse.
Wall Street traders immediately seize the opportunity to broadcast near real-time quotes on share prices allowing fast and furious trading everywhere - these were the first stock tickers.
"Bucket shops" are setup across the country where any trader could use leverage from pooled funds to buy and sell securities as they streamed out of the stock tickers.
As one clerk would read out prices coming from the telegraph, another would take buy and sell orders and write them on a chalk board.
These were the earliest order books and what we still use to this day in the modern stock market and even with traditional centralized crypto exchanges.
It has two columns - a list of sell orders & a list of buy orders - both with a quantity available and price at which they are willing to settle the trade.
Why am I going to all these lengths to explain this?
Well it's interesting.
But more importantly, fundamentally all these trades are one-to-one. Meaning, you take an order off the books even when your order spans more than one offer.
This happens because there isn't a single source of truth from which to pull orders but that all changes with public blockchains and specifically automate market makers (AMM) on Ethereum.
UniSwap: A Constant Product AMM
How it works
Imagine you took the entire order book on a centralized exchange like Coinbase and compressed into two giant buckets - one for each side of the market.
You then allow trades to be made according to a pre-defined algorithm.
This algorithm, an automated market maker (AMM), quotes prices to the end user according to some pre-defined rule set.
The Uniswap DEX is a constant product AMM where all trades comply to the following formula:
x * y = k
Wherein x and y are quantities of tokens and k is the constant.
Uniswap's only stipulation is that this k must remain constant as trades are performed by anyone, anywhere and at anytime.
Let's run through an example
A market starts with pools of 100,000 DAI (x) and 1,000 ETH (y) as a result our product is 100,000,000 (k) and our computed price of ETH is $100 (100,000 DAI / 1,000 ETH).
If someone wants to buy 1 ETH - they can deposit 100 DAI (ignore fees for now) to bring our total to 100,100 DAI and 999 ETH - our product remains 99,999,900.
Whooops.
So I wanted to show this because it explains the premium that needs to be applied based on the order size to keep the product constant
In this case it would be a 0.10% premium.
Let's try this again 1 ETH for 100.10 DAI brings the total to 100,100.10 DAI (x) and 999 ETH (y) for a constant product of 100,000,000 (k).
And the key is this scales asymptotically with order size.
Source: Uniswap: A Unique Exchange
Here's what we can take away from this:
Premium Charge: The size of the premium is proportional to both the pool size and order request. Larger pools can absorb larger orders with less slippage.
Long Tail of Coins: Markets can be made for even the most illiquid coins. Anyone can add liquidity and earn fees from any market.
Programmatic Transactions: AMM allow for programmatic transactions by smart contracts without having to worry about slippage on large enough pools.
Determine Profit & Loss
As mentioned, anyone can add liquidity to any pool.
In the example above, you can add say 1,000 DAI and 10 ETH (both must be supplied at the same time to keep our k constant) and will be given liquidity tokens for your proportional share of the pool.
These can be redeemed at any time for your share of the pool's DAI and ETH.
The challenge is that your profit or loss is contingent on multiple factors including pool size, the price of the assets and pool trading volume
You can read more about it in these two fantastic articles: PNL Analysis of UniSwap Market Making and Understanding Uniswap Returns.
I'll summarize the main finding here:
Assuming the pool size remains constant, the optimal return is achieved when price of the assets remain constant from when they were added and increases as more volume is traded through the pool.
You can see it in this visual:
Source: PNL Analysis of UniSwap Market Making
Some best practices then appear from this:
Large Pools: Look for larger pool sizes with lots of liquidity that are growing over time. You don't want to chase the latest pump as volumes & liquidity can fluctuate wildly.
DCA Liquidity: Since returns are dependent on the price of assets at provisioning, it would make sense to add liquidity over time to achieve optimal returns. I have yet to test this thesis.
Luckily there are some tools you can manage your pools and monitor your ROI:
Uniswap ROI: Paid service that allows you to monitor all your pools as well as search for pools that are profitable. Includes projections for the next 30 days and they are building an automated pool allocation tool.
Zapper.fi: Allows you to add to pools using only one asset. Say you have ETH and want to add to the DAI-ETH pool, you can zap in your ETH and it'll buy the right proportion of DAI before adding it.
Pools.fyi: Let's you see historical ROI for the last 30 days as well as a tool to monitor and track your pools performance. Very similar to Uniswap ROI but I haven't yet had time to test either tool so use them at your own discretion.
According to Pools.fyi, the 30 day ROI on USDC-ETH pool is 1.27%
How it changes money
We're moving from a financial system that isn't inclusive by design.
When Wall Street was born it was explicitly an insider crowd that brought in liquidity and profited off the exclusive access to it.
Centralized exchanges to this day offer benefits to market makers including reduced trading fees and who knows what else behind the scene to entice them to provide liquidity to their markets.
With AMMs, you're now interacting with an algorithm - the game has been set and you can decide to participate or not. Moreover, if you bring any liquidity to the table you are rewarded for share of the pie.
It completely levels the playing field.
And can be done from the bank account in your pocket.
More important, it's now programmatic - if you make a trade from a smart contract to a large enough liquidity pool - you can be assured a good rate with low slippage.
What it means for how we store wealth is even more profound because you never have to store your wealth in assets / currencies you use but instead in the BEST asset at any given time.
Let me give you an example, if you live in Venezuela you interact in the economy in Bolivars but often you save in US Dollars. If both are digitized, you can save all your wealth in USD and when you need to spend in Bolivars, you can do so in a single transactions.
See this image:
Source: AMMs & Public Blockchains - Where x is US Dollars and y is Bolivars
As a result, where you choose to store your wealth becomes even more critical and will likely be the asset or currency that best retains its value over time.
I believe that will be Ethereum and Bitcoin.
Adding Liquidity to Uniswap (5 mins)
You must have both tokens for any pool you want to add funds to...
Go to Uniswap.Exchange
Click "Pool"
Select the pool you want to join
Approve tokens for deposit
You need to allow Uniswap to manage the tokens on your behalf. It will request your approval and you will need to submit a transaction.
Click "Supply"
Adding Liquidity to Uniswap using Zapper.fi (5 mins)
Zapper will find the asset you don't have and deposit it in the pool for you.
Go to Zapper.fi
Click "Invest"
Select your pool and click "Add Liquidity"
Click "Confirm"
What do you want to see me cover next week? Post in the comments and I’ll explore the topic in a future edition of this newsletter.
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Around The Space
Ethereum accounts pass 100M
In only 5 years, Ethereum accounts have passed 100,000,000 showing wide adoption of the network. Compare this to the number of websites that took 15 years to reach the same milestone. I think because all the infrastructure of the web has already been built, the cryptospace will gain mass adoption in a much faster. We are currently at 100M accounts, 270K tokens and $1B of value locked in DeFi smart contracts.
Potion insurance is an AMM for insurance
We talked today about AMMs but the concept can be extended to any algorithmic market and it's starting with insurance / options. Potion Insurance uses the Black Scholes model, an options pricing model, to allow anyone to get insurance on any asset, at any limit and at any expiration term. For instance, you could buy BTC Potion 5000 for insurance against BTC price drops below $5000. Do the same for MKR Potion 243, Gold Potion 100, SP500 Potion 2500 - you name it!
Loopring launches Pay: zkRollup transfers
We talked a few weeks ago about Loopring - a scalable layer-2 decentralized exchange that offered 2,025 transactions per second using zkRollup. They've now launched a service to allow their users to transfer funds between wallets instantly and with zero fees. I'm still going to hold out for a more slick mobile wallet interface but it shows we can have scalable transfers on L2 of Ethereum today.
FED backs alternative to LIBOR using Ethereum fork
LIBOR is a widely used benchmark for short term interest rates that was hit with a series of scandals where bankers manipulated the lending rate resulting in billions of dollars of losses for US municipalities. AMERIBOR, built on a permissioned version of Ethereum, serves as a replacement and was given an endorsement by the FED chairman - Jerome Powell. Even though it's on a permissioned fork expect it to be pulled in and compatible with the public chain in the future.
MakerDAO considers accepting real world assets as collateral
Maker DAO - the most popular DeFi project to date and with over $500M in value locked in its contract is considering accepting real world assets as collateral. This has been a contentious issue for sometime but has always been the goal of the team. With more assets as collateral, they can issue more loans but this also increases the risk profile of the underlying DAI that is issued. They are exploring adding supply chain invoices and musician's future royalty streams.
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Disclaimer: Statements on this site do not represent the views or policies of anyone other than myself. The information on this site is provided for discussion purposes only, and are not investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities.