Understanding Poolside V1
A next-gen DEX for yield-bearing tokens!
Did you know that liquidity providers (LPs) are losing their staking rewards and yield to insufficient AMM design? What's worse is these losses are permanent and heightened by design choices. This means existing DEXs can't facilitate deep markets for yield-bearing tokens.
This changes with Poolside V1.
Poolside is a new and exciting DEX live on Ethereum, Avalanche, and Base! Built on an innovative AMM protocol, it eliminates yield loss and optimizes the experience for LPs. This is thanks to critical new infrastructure and a novel rewards program.
Earn swap fees. Earn incentives. Keep your yield.
Token & AMM Design
Understanding Poolside requires a basic understanding of both token and AMM design. Although Poolside can trade any token pair, it works best for yield-bearing tokens. The primary examples are liquid staking tokens and receipt tokens from lending protocols. As these categories mature, tokenized real-world assets and yield-bearing stablecoins will also benefit from Poolside's design.
Protocols that issue yield-bearing tokens must decide how the yield is distributed to token holders. In DeFi, the prevailing token designs for this have been rebase tokens or ones based on cTokens. While these token designs achieve similar outcomes and work fine for entering and exiting positions through the token issuers, they both suffer inside liquidity positions. This is because AMMs need a way of understanding when yield is distributed.
This means yield that belongs to LPs has either been lost or leaked away to arbitrage in existing AMMs. Clever marketing and incentives have masked this truth. Poolside solves this by introducing reservoirs and wrappers. Before diving into our solutions, we should explain the basics and clear up some misconceptions.
DEXs are decentralized marketplaces that facilitate permissionless trading of crypto assets. They are built on top of one or more AMMs, which determine price using algorithms. This category has seen a lot of exploration since Uniswap first pioneered the constant product formula. Curve's StableSwap is another example of an implementation that optimizes for pegged assets. Trader Joe and Maverick utilize Liquidity Books, AMMs which have proven to be successful in optimizing for trading volume.
We’d like to remind DeFi participants that, like with many other things, there are trade-offs when it comes to AMM design. There is no free lunch. One misconception is that AMMs designed for pegged assets solve for yield-bearing tokens. Yield-bearing tokens introduce the financial concept of elasticity to DeFi. This elasticity is expressed in the supply of "a token" at some point. With rebase tokens this elasticity appears directly in the supply of the tokens. With cTokens it occurs in the amount of tokens the receipt can claim.
AMMs rely on the balance of token reserves as one of the inputs to determine price. This means yield-bearing tokens become mistakenly cheaper when yield is distributed. This is because AMMs can’t differentiate between a change in value due to yield versus typical trading activity. Let's dive into the two token designs to understand this more fully.
stETH, for example, is a representation of ETH collateral committed to validators to earn ETH rewards for securing Ethereum. This means that stETH is a receipt for an amount of the original ETH collateral and the accrued ETH rewards. stETH being a rebase token, when rewards are distributed, the entire supply of stETH changes to match the underlying ETH.
This elasticity in supply offers a familiar UX to traditional finance. Think of interest distributions to a savings account. The number of dollars in that account changes. Similarly, ETH rewards show up as more stETH in users' wallets. The drawback with rebase tokens is the technical difficulty in integrating them. Maverick and Uniswap state in their documentation that rebase tokens aren’t fully supported.
The problem with rebase tokens inside AMMs stems from the volatility in the supply. Since AMMs use the balance of reserves as one of the inputs to determine price, any fluctuation of the token supply will render a new price calculation. So when stETH earns staking rewards, the supply of stETH in a pool goes up, which means that stETH will become cheaper against the other token. This leaves the pool vulnerable to arbitrage. LPs will lose their expected yield and earn less in swap fees as their deployed liquidity has become cheaper.
Yield-bearing tokens based on cTokens can be minted or burned according to a floating exchange rate. The majority of liquid staking tokens use a form of this design. Let's use Rocketpool's rETH as an example. rETH is also a receipt for an amount of staked ETH collateral and accrued ETH rewards. When ETH rewards are distributed to rETH holders, the supply of rETH doesn't change. What changes is the exchange rate, so the amount of ETH that rETH can redeem with the primary issuer becomes larger.
While this token design is more straightforward to integrate, providing more DeFi opportunities in the near term, it does introduce some quirks. Because rETH is not pegged to ETH and is continually representative of more staked ETH, it will experience divergences in price over time. These divergences are vulnerable inside liquidity positions, especially inside AMMs for pegged assets.
When staking rewards are distributed to rETH holders, the token becomes intrinsically more valuable, as rETH can claim more ETH than before. This creates value leakage inside AMMs because the price between a pair doesn't change despite the value of rETH increasing. Again, AMMs need help understanding when a token's value has changed outside of the pool. LPs lose their yield to arbitrage as the market price doesn't reflect the value change. Inside AMMs that optimize for pegged assets, less liquidity facilitates more potent trading, but all this means for yield-bearing tokens is that this arbitrage occurs more efficiently.
Poolside is an opinion on DeFi's future and an innovation on AMM design to solve the problems above. In traditional finance, we've seen the importance of yield, especially risk-free yield in the form of treasuries. DeFi has an opportunity to onboard more of this market on-chain and also has its own quickly growing native yield offerings. This is why an AMM that removes yield loss is essential to scaling DeFi.
Poolside V1 removes this yield loss by introducing reservoirs and wrappers. These pieces of infrastructure achieve two things. Wrappers unify yield-bearing tokens by standardizing them into rebase tokens. Reservoirs modulate a pool’s reserves by adding two additional token balances. This means our AMM can recognize a token’s supply change as a yield distribution event.
These innovations allow yield to accrue in reservoirs, pockets of inactive liquidity. This maintains an accurate pool price when yield is distributed. Tokens inside a reservoir can be added to the pool under certain constraints. This means that yield is never lost but preserved for LPs. So, yield that would have been lost in other AMMs is productive for LPs in Poolside.
Earn even more with your yield.
An observation that Poolside makes is the importance of AMMs to greater DeFi. AMMs facilitate permissionless trading and are integral for truly permissionless markets. Issuers of yield-bearing tokens and other DeFi protocols rely on liquidity inside AMMs to facilitate financial activity. Without the liquidity inside AMMs, it would be difficult for auctions, liquidations, and flash loans to occur. Without these things, issuers of yield-bearing tokens won’t be able to see their assets used in DeFi as collateral for lending or stablecoins.
Issuers of yield-bearing tokens also benefit from liquidity inside AMMs by being an alternate way for users to enter or exit positions. If everyone exited their liquid staking positions by withdrawing directly from the issuers, the collateral being productive with validators gets disturbed. If these withdrawals are large enough, it could affect expected rewards and protocol health.
This is why LPs for yield-bearing tokens will continue to receive incentives as DeFi scales. The problem with incentives on AMMs where yield loss occurs is that it’s challenging to get LPs to remain after the incentives leave. Why would they? The incentives only make up for the yield loss they are experiencing near-daily. This also means that incentives deployed by protocols or DAOs get wasted, compensating for insufficient AMM design. This is one of the reasons why the ETH/stETH pool on Curve shrank from ~$5.9B to ~$220M in less than 24 months. Poolside solves this yield loss and can facilitate deep liquidity for yield-bearing tokens.
Poolside Party is a novel take on incentives based on Ampleforth’s Geyser V2. Poolside Party allows LPs to earn multiple incentives without liquidity tokens ever leaving the user’s wallet. Rewards programs can be used to distribute any on-chain incentives algorithmically, like ERC-20s and NFTs. Poolside Party will launch with our own Party Points program, and some pools will also be incentivized with tokens from strategic partnerships.
Rewards programs can also have multipliers! LPs can earn at higher rates based on thresholds set by the rewards program. This aligns incentives with protocol needs and can be used to reward specific types of participants. Poolside’s Party Points will have multipliers, and points will be redeemable for Poolside’s governance token in the future!
Ready to earn swap fees and multiple rewards? While also keeping your yield? Dive into Poolside today!