OPRR Flash Depth Activities

Search Extension

Can the NFT AMM protocol lead the decentralized transformation of the NFT market?

2022-12-21 22:00

Read this article in 29 Minutes

AI summary

View the summary

Can the NFT AMM Protocol Lead the Decentralized Transformation of the NFT Market?

原文作者： IRVING

The year 2021 saw the rise of the NFT market, the explosion of NFT asset prices that created countless wealth myths and the popularity of the once niche concept. However, in 2022, Yuga Labs' metaverse land became the last song of the NFT bull market, and then the heat of the NFT market subsided. A number of shortcomings in the NFT market have brought renewed concern, not least the illiquidity of NFT assets. Launched in July 2022, SudoSwap brings AMM mechanisms and the possibility of decentralized trading to the NFT market, breaking the monopoly of centralized exchanges on the NFT market. So, is NFT Fi protocol represented by NFT AMM the key to this round of NFT bear market breaking?

I. Overview of NFT-Fi

(I) Definition and application of NFT-Fi

NFT-Fi is short for Non-fungible token finance, which can be translated as "non-homogeneous token finance" in Chinese. The aim is to bring greater liquidity and financial transactions to non-homogeneous tokens (NFT) to address the pain point of the lack of liquidity in the NFT market. The NF-Fi ecosystem covers nine verticals, including lending, pricing, Buy now Pay later (BNPL), fragmentation, leasing, derivatives, liquidity provision, trading markets and industry infrastructure.

(II) Industry status quo of NFT-Fi

The basic concept of NF-Fi is derived from the de-centralization of financial products (DeFi), so like the DeFi market, the development of the NF-Fi industry is largely determined by the amount of total value locking (TVL) in the market. Currently, the NFTFi market TVL is about $175 million [2], dwarfed by the DeFi market TVL of $54 billion [3]. Although NFT Fi is still relatively early in its development compared to DeFi, the market has generally been more positive about the future of the NFT market since the NFT Summer of 2021 (a period when prices of various collections in the NFT market increased dramatically). Even in April 2022, Yuga Labs' Otherdeed for Otherside, publisher of the famous Ape Boring (BAYC) NFT product, became the swan song of the NFT bull market. The bearish NFT market is also prone to new hits. The journey of exploration and innovation in the entire NFT market does not end there. Art Gobblers5, backed by cryptocurrency venture capital firm Paradigm, sold more on its first day than Bored Ape's total sales in the past month, which is not uncommon in the NFT market. How to help the NFT market develop better and faster by means of various financial means has become the main challenge NFT Fi faces.

Figure 1: Top NFT series data sources by volume: NFTGo, November 2022

Ii. Definition and application of NFT AMM

The automatic market-making mechanism for non-homogeneous token assets is NFT AMM, which is part of the liquidity provision circuit in the nine vertical areas of NFT Fi, and its rationale is derived from decentralized finance (DeFi). The NFT AMM protocol provides new trading options for NFT investors, who can combine a specific NFT with Ethereum (ETH, the main settlement token used to trade NFT on the Ethernet backbone) into a trading pool with a specific swap ratio. Other NFT users can buy NFT from the trading pool or sell NFT directly to the trading pool. Any purchase or sale made in a pool generates fee income for the owner of the NFT pool. The advent of the NFT AMM protocol has greatly improved the experience of some NFT sales. NFT6 holders do not have to wait hours or days after placing an order on a centralized NFT exchange such as OPENSEA (currently the largest NFT exchange on the Ethernet mainnet). In order to sell their NFT assets. Transactions on NFT AMMs are done instantaneously on the blockchain system and are usually not subject to royalties.

Figure 2: Nine vertical tracks and key players in the NFT-Fi ecosystem Data source: Collect.xyz

According to the market share of NFT on the Ethernet chain, NFT AMMs represented by SudoSwap are more of an alternative to centralized exchanges at the present stage, which can make up for market liquidity to a certain extent.

Table 1: The top 10 markets in terms of ether chain trading volume in November, 22, except SudoSwap, are all centralized exchanges or trade aggregators, data source: NFTGo, November 2022.

3. Major participants of NFT AMM circuit

(1) Pioneer SudoSwap

SudoSwap, deployed on the Ethernet mainnet, was a precursor to the NFT AMM pattern, originating from the liquidity swap pool provided by founder 0xm for his NFT project 0xmons.

SudoSwap for the first time applied the concept of decentralized transaction (DEX) in the DeFi project to the field of NFT, and opened up a fast exchange channel between homogeneous token 1 and non-homogeneous token 2. By optimizing the transaction curve 3 of traditional DeFi projects, SudoSwap eliminates the disadvantage of high transaction slip point 4 on traditional DEFI projects, so that it can be applied to NFT projects.

Table 2: Explanation of the Concentrated XYK trading curve adopted by SudoSwap's official tweet

Data source: SudoSwap official Twitter

In view of the main contradiction of NFT's lack of liquidity -- the difference in value brought by the non-homogeneity between different tokens, SudoSwap adopted a relatively "simple and crude" way to solve it. That is, all the NFT's are considered to be the same price, regardless of the differences among the individuals of the same NFT collection.

SudoSwap launched Ethernet mainnet in early July 2022. Its novel trading mode and low transaction cost (SudoSwap only charges 0.5% agreement commission and does not pay royalties, which is significantly lower than the 8-10% transaction cost of OPENSEA and other centralized exchanges). Combined with the expectation of a strong Airdrop (a reward system for early adopters of the community), it quickly attracted a large number of NFT users, and its TVL quickly climbed from under $300,000 when it launched in early July to over $3 million by the end of August.

However, SudoSwap's subsequent development was not very positive. The airdrop expectation brought in a large number of seed users, but 0xmon gave most of the airdrops to the SudoSwap team and 0xmons NFT owners. This has led to widespread discontent among early adopters of SudoSwap, and market expectations have shifted from optimism to FUD (Fear Uncertainty Doubt, a term often used to describe pessimism in the crypto currency world). As of November 2022, SudoSwap is still the largest TVL NFT AMM protocol deployed on the Ethernet mainnet, but has been surpassed by a rival HadeSwap deployed on the Solana chain (a blockchain network not compatible with the Ethernet mainnet).

Table 3: TVL changes since the launch of SudoSwap, data source: DeFiLlama

(2) Catching up with HadeSwap

The HadeSwap protocol deployed on the Solana chain went live on September 26, 2022, and is known as "SudoSwap on the Solana Chain". HadeSwap uses the same basic model as the transaction curve and SudoSwap, except for the deployed blockchain backbone, but HadeSwap quickly came out on top. According to Hadeswap's official website, its TVL as of December 1, 2022 has reached 234,500 SOL coins 10 (the original token of Solana chain), equivalent to $3.28 million, which is higher than SudoSwap's $1.88 million in the same period.

Unlike the ups and downs after the launch of SudoSwap, HadeSwap's growth path is more stable. While SudoSwap accounts for less than 1% of the total Ethereum NFT transaction volume, HadeSwap has become the second largest Solana NFT market. According to the data of TIEXO[7], the market share of HadeSwap in November 2022 was 4.71%. Although there is still a big gap between Hadeswap and Magic Eden, it is also significantly higher than other competitors in the market.

Table 4: HadeSwap, which was launched in September, 22, has become the second largest Solana NFT market in terms of transaction volume.

Data source: TIEXO

The fact that SudoSwap and HadeSwap are two identical trading schemes with very different results in different NFT markets is puzzling, and there are many explanations in the market. One possible explanation is that there is a significant difference between the two NFT trading ecosystems.

OPENSEA, the NFT exchange on the Ethernet chain, has a dominant position in the NFT market. Although its share of trading volume has been gradually shrinking under the encroachment of various competitors, its system has a profound impact on the NFT market of the Ethernet chain. For example, OPENSEA labels suspected stolen NFTS and prevents them from being traded on OPENSEA marketplaces, which is the opposite of decentralization. Other centralised NFT exchanges on Ethernet chains, in order to avoid flooding their markets with OPENSEA's labelled NFT, have also adopted varying degrees of labelling and restriction. This eventually resulted in a large number of stolen NFT flagged by OPENSEA flowing into the NFT AMM protocol without centralized auditing, which undoubtedly greatly hindered the benign development of Ethernet NFT AMM protocol. On Solana's NFT market, there is no such thing as OPENSEA's mandatory labeling of NFT assets. HadeSwap has thrived on the Solana chain in part because of this.

In addition, another difficulty SudoSwap faces is that there are a large number of individual traders on OPENSEA who supplement the liquidity provision function to a considerable extent by offering NFT prices. Aside from the expected airdrop and lower transaction costs at the beginning of the rollout, NFT sellers have little incentive to use SudoSwap. On the other hand, HadeSwap, Magic Eden does not have such a large amount of liquidity provided by OPENSEA as an alternative, which indirectly leads to HadeSwap successfully finding and stabilizing its ecological position. However, Magic Eden12's market share is fast approaching that of HadeSwap as it launches its AMM solution in partnership with NFT market aggregator 6CoralCubeNFT at the end of November 2022.

(3) Challenger LinoSwap

SudoSwap's seed users didn't get to wait for SudoSwap's airdrop, but in November 2022, they received a surprise airdrop from SudoSwap's competitor, LinoSwap.

LinoSwap and SudoSwap are both NFT AMM protocols deployed on the Ethernet backbone and use a very similar transaction curve. However, the emphasis of the two is different. SudoSwap deliberately weakens the non-homogeneity of NFT and treats all NFT as having the same price. LinoSwap chose a different path, not affecting the high liquidity of the NFT AMM protocol, but also partly taking into account the differences in value between non-homogeneous NFT tokens.

In actual NFT transactions, NFT values with different Traits often differ greatly. The market uses rarity to score and rank NFTS of Traits. Take the Boring Ape (BAYC) as an example 7: BAYC ordinary (BAYC #7292) has a rarity score of 932.82, ranking 8624 in rarity 8. Its listing price is about 70 Ethereum pieces (about $90,000). BAYC Rare (BAYC #544) (with Solid Gold rare feature) has a rarity score of 3585.09, ranking 33rd in rarity. Its listing price is 1000 Ethereum pieces (about $1.3 million). The price difference is 930 Ethereum ($1.21 million).

Figure 3: There is a huge difference in value between rare BAYC NFT and common BAYC NFT. Data source: Rarity Sniper

It can be seen that the value of NFT with different rarity may vary greatly. When the holders of rare NFT need liquidity, they will not usually choose SudoSwap, which does not consider the rarity of NFT. It relies more on peer-to-peer lending agreements such as BendDao. LinoSwap introduced the concept of rarity into NFT AMM protocol, which is trying to solve the pain points of NFT AMM protocol.

LinoSwap adopts the rarity score calculation logic which is highly recognized in the NFT market. By calculating the occurrence frequency of various features in the NFT series and combining with the number of features of a particular NFT, the rarity score of the NFT can be obtained. Based on the rarity score, the rarity ranking of the NFT in the series was determined.

Figure 4: Rarity ranking of NFT based on its characteristics can be obtained from Rarity Sniper

The ultimate purpose of obtaining the rarity ranking is to accurately estimate the value of NFT. In LinoSwap's solution, a Pareto distribution is introduced to simulate the price distribution across a series of NFT's. In the actual price curve used by LinoSwap, the NFT with the lowest rarity in the series is called the benchmark NFT, while the rest are based on the rarity ranking and follow the Pareto distribution to determine their rarity premium. However, when a certain NFT is too rare, its assessed price will be significantly higher than the benchmark NFT, resulting in a higher trade slip point and liquidity shock 9. In response, LinoSwap put a cap on the price of rare NFT transactions in the agreement to mitigate the impact of rare NFT transactions. At the same time, if NFT AMMs become the dominant mode of trading in the NFT market in the future, deeper TVLS will effectively mitigate the liquidity shock problem.

Figure 5: LinoSwap official promotional materials for the introduction of its dereto distribution curve,

Data source: LinoSwap Official OnePage

With the introduction of the concept of rarity, LinoSwap can cover a greater range of NFT than other similar AMM protocols, which has the theoretical possibility to replace centralized exchanges.

Figure 6: LinoSwap's main differences from other NFT AMMs are well explained in the official publicity materials,

Data source: LinoSwap Official OnePage

It is a positive attempt to introduce rarity into NFT AMM protocol by LinoSwap, but there are some defects: the NFT rarity algorithm adopted by LinoSwap is to convert the occurrence probability of all NFT features into scores and add them together, assuming by default that the weight of 16 of all features in NFT series is the same. However, this is not entirely consistent with the reality of the market, NFT collectors are more likely to collect NFT with certain characteristics, rather than focusing solely on the rarity score of NFT.

Figure 7: Two BayCs with similar rarity scores have huge differences in actual transaction prices, data source: NFTFILP.AI

In addition, since there is no universally recognized calculation system for the rarity of NFT in the NFT market, the evaluation methods of different NFT series are different. The value of a particular NFT depends more on the consensus of the NFT community.

For rare NFT valuation, predictive machine solutions (such as Upshot) based on machine learning models that analyze historical transaction prices for NFT may be a more mature and reliable option.

Iv. Prospect of NFT AMM market

(1) Low rates and zero royalties lead to changes

In a bull market, the NFT market does not have a strong demand for zero royalties. But at a time when the market is in a slump, trading fees as high as 6 to 12 percent (including 5 to 10 percent of royalties plus 0.5 to 2.5 percent of market fees) are a pain in the neck for many NFT traders.

SudoSwap's zero-royalty policy is not its greatest competitive advantage, but it is the first shot in the NFT royalty revolution. In mid-August 172022, when SudoSwap volume was at its peak, Ethernet NFT exchange x2y2 quickly realized that change was coming. It was the first to launch a custom royalty feature that allowed buyers to choose between 0%, 50%, and 100% of the royalties they would pay when buying NFT. In late October 2022, the LooksRare Exchange also announced the activation of optional royalties and to compensate creators for the loss of royalties by adjusting the way LOOKS Tokens (governance tokens issued by the LookRare Exchange) distribute their pledge rewards. Blur Exchange, which went online at the end of October 2022, aggressively seized the market by adopting the strategy of 0 royalty +0 transaction fee, which started the first zero-cost transaction of NFT. Blur significantly dominated the trading liquidity and order depth of Art Gobblers and KPR in early November, and surpassed OPENSEA for the first time.

Table 5: Blur surpassed OPENSEA in trading volume in early November thanks to zero royalties and the Art Gobblers project.

Data source: Dune

In response, OPENSEA, the largest exchange on the ether chain, and Magic Eden, the largest NFT market on the Solana chain, both launched royalty protection tools to consolidate their market share by protecting the 18 tax income of the creator version, so as to maintain the commission income they rely on for survival. Underpinned by the market share of both, NFT deals with mandatory royalties will remain the order of the day for the foreseeable future.

However, doubts about high royalties in the market have not been eliminated. The original intention of NFT traders to pay royalties is to supplement the income of the creators, so as to support the creators to continue to build the project after the release of the project and bring more value to the community. But in the current NFT market, this logic does not seem to hold. Even Yuga Labs, the leader in the NFT industry, still derives its main source of revenue from the primary market sales of its NFT.

Table 6: Yuga Labs' main operating income also comes from NFT's primary market sales, data source: Yuga Labs

Although NFT AMMs currently rely more on low transaction costs brought by zero royalty, encroaching on AMm-like mechanisms in centralized exchanges to gain market share. But in the long run, if low or even zero royalties become the mainstream of NFT trading, it will undoubtedly be a better outcome for NFT AMMs, which rely on trading volume for profit.

(2) Industrial infrastructure needs to be improved

Although NFT AMM, led by SudoSwap and HadeSwap, has taken a place in the NFT trading ecosystem, it still has a long way to go to shake the dominant centralized exchanges such as OpenSea and Magic Eden.

At present, the main target group of NFT AMM coverage is the NFT with low rarity scores in the category of blue chip NFT (refers to NFT assets with high value). LinoSwap tried to introduce rarity into NFT AMM protocol, but the calculation method of rarity and the valuation method of rare NFT have become urgent problems to be solved. These issues may not be addressed until the NFT industry infrastructure, such as the NFT valuation predictor, matures, which will limit the expansion of the NFT AMM protocol in the direction of rare NFT.

In addition, how to effectively link NFT AMM and DeFi through exchange protocol-based infrastructure, to provide liquidity for the larger proportion of long-tail NFT assets, will also be another major challenge to NFT AMM protocol.