Phezzan is bringing retail liquidity to orderbook DEXs
Disclaimer: All things presented here are just high level thoughts, illustrations, or concepts. There are lots of details the Phezzan team needs to figure out. There will definitely be risk when providing liquidity on Phezzan Protocol. Nothing here is financial advice, DYOR.
Back in late 2021, the 2 founders of Phezzan shut down their last startup, a screen sharing App that once reached top 100 spot in Apple App Store Social Networking category. That business was not profitable but we made something people want. To this day, every week users come to us asking when we would bring the app back.
Being long time traders ourselves, we started to look into the DEX space as L2s were booming back in late 2021 as well. We tried all kinds of DEXs and came to the conclusion that they were no match to their CEX counterparts. If DEXs are the future, what kind of DEX is needed to beat CEXs in 5 years?
Now let’s dive in and take a look at all the different DEXs and their problems. Since Phezzan is a perpetual DEX, we will mostly talk about perp DEXs.
AMM and its variations (vAMM, PMM, etc) are the dominant methods used by perpetual DEXs today. It is truly one of the biggest wonders of DeFi: bootstrap liquidity, a place to earn yield for retail LPs, and endless composability. For some trading pairs, Uniswap has 2x ~ 3x the liquidity compared to Binance or Coinbase.
Simply put, dYdX is probably the best perpetual DEX nowadays. High volume, fast transaction speed, small fees, and lots of liquidity.
The problem with orderbook perp DEX is that as a retail LP, you have nothing to do with it. You can’t provide liquidity and can’t earn yield. Professional market makers provide their own liquidity, decide which trading pairs they are comfortable with, and make markets.
Professional market makers have low appetite for highly volatile assets and generally take a long time to evaluate the risks for new markets. For example, the dYdX community voted almost 3 months ago asking to add a few new trading pairs such as $APE/$GMT and those trading pairs are constantly top 10 among major CEXs, nothing has happened yet.
Oracle style DEXs, such as GMX, have attracted lots of attention in recent days.
The problems with oracle style DEXs are a little more complicated. Let’s only speak about the downside of being an LP there. For LPs in an oracle style DEX, they are essentially betting against the traders. LPs in oracle style DEXs have unpredictable earnings because they have to accept all orders with a predetermined oracle price whether that trade is favorable or not.
Simply put, if the traders are good, LPs in the oracle style DEX are rekt.
The pros and cons of the 3 types of DEXs above can be summarized into the following table:
Since oracle style DEXs don’t have price discovery, it’s unlikely that they will be the dominant method in the future. That leaves us with two options:
1. Design some really good AMM algorithms so there is no impermanent loss. The Phezzan team is simply not capable of that.
2. Bring retail liquidity to orderbooks. Let everyone make markets in an orderbook style DEX lazily as if they were in an AMM style DEX, but without impermanent loss.
That is exactly what Phezzan will do. Phezzan Protocol will be an orderbook style perpetual DEX that enables retail liquidity.
LPs don’t have to take a bad trade. It is capital efficient, and there is no impermanent loss. Volatile assets are supported in a permissionless way, and price discovery happens on Phezzan itself.
Let’s dive in.
Before I get into any more boring details, let’s take a look at how providing liquidity on Phezzan Protocol will look like.
When LPs enter Phezzan Protocol website, they will see the Phezzan Liquidity Marketplace. This page shows all kinds of orderbook market making strategies ( “MM Strategies” ), which are bots and algorithms used by professional market makers when they make markets on orderbooks.
You can imagine each MM strategy as a separate hedge fund, where hedge fund managers (MM Strategy Owners) get some capital from investors (LPs), invest (make markets) on their behalf, and take a commission if profitable.
LPs can see some basic information of each MM strategy, such as the associated market, name of the strategy, developer, TVL, APY, commission rate, launch date of strategy, and if it has been audited.
Just to be clear this is just an illustration so there are only 4 MM strategies. In the future we expect there to be hundreds, if not thousands, of MM strategies there. LPs can search, sort by criteria, and manage their liquidity easily.
Then LPs can click any single strategy that they are interested in to see the details. There is lots of information on this page. Let’s get to them.
On the top left side, you get the Pool Info and Description. Those are the basic information about this strategy and they are pretty straightforward.
Please note that all that information is customizable. Listing a strategy on Phezzan is permissionless, which means the strategy owner gets to control all that info.
Why do people provide liquidity to a pool in other DEXs or a strategy in Phezzan? To earn some nice APY!
In the chart above, potential LPs can see the APY history of a particular MM strategy.
Like APY, above is the history of TVL on a particular MM strategy.
This part shows an LP’s total position in a particular strategy and relevant information.
Since MM strategy owners may want to control inventory risks and a steady cash flow for their market making activities, there may be lock up time requirements for MM strategies. LPs can provide different liquidity positions for a single MM strategy with different amounts of capital and lock up time.
For example, the LP in the chart above provided two separate liquidity positions for the same MM strategy: one with $300,000, and the other with $202,154. These two positions unlock on different dates.
LPs can not withdraw their capital prior to the unlock date unless there is something unusual with the MM strategy itself, such as change of code, change of Profit Sharing Mechanism, etc.
The minimum lock up time in Phezzan will be 7 days and maximum will be 365 days. Anything shorter than 1 week raises problems for MM strategy owners and anything longer than 1 year is too long for the volatile crypto market. A strategy owner can set its lock time requirements within the 7 to 365 days range. There will be an option for LPs to auto-redeposit into the same MM strategy.
Now let’s go back to “Profit Sharing Mechanism”, and that’s where things get interesting.
When a strategy is making markets, there are three sources of revenue/profits.
“Fee” is the trading fee rebate from Phezzan Protocol. A part of the trading fees will go to Phezzan Protocol and the rest will go to MM strategies.
“Reward” is Phezzan token distributed to MM strategies.
Unlike other DEXs, Phezzan will not distribute PnL/Fee/Reward to individual addresses. Instead, Phezzan Protocol will distribute PnL/Fee/Reward to each MM strategy.
MM strategy owners will set up the Profit Sharing Mechanism to divide revenue/profits between themselves and LPs who provided capital to their strategies.
Different MM strategy owners have different market making styles thus different requirements for liquidity. Alice might be a high frequency market maker so Alice needs lots of capital but cares less about how long those capital are locked. Bob is old school and is willing to hold some position for sometime, so Bob prefers a steady stream of liquidity over lots of liquidity in a short period of time.
Different LPs may also have different appetites for MM strategies and rewards. Clare may prefer more Phezzan tokens while Frank wants a bigger chunk of profits from the spread.
The point is, the Phezzan team does not know and will never know what’s the best Profit Sharing Mechanism between MM strategy owners and LPs.
Since for LPs there are many MM strategies to choose from, Phezzan Protocol will just let MM strategy owners design the Profit Sharing Mechanism for themselves. MM strategy owners will set up their Profit Sharing Mechanisms to attract the liquidity they want, to have a balance between their and LPs’ profits, and to compete against each other.
An MM strategy owner can set 10% commission to quickly get some market share or 90% commission if that MM strategy owner is confident enough.
There will be a 5% minimum strategy charge percentage to avoid destructive competition and Phezzan will take a flat fee to cover MM strategies related expenses.
If LPs do not like MM strategy A’s Profit Sharing Mechanism, they can provide their liquidity to a more preferable MM strategy.
Let’s take that even further.
When LPs deposit their capital into a MM strategy, Phezzan will issue ERC-721 tokens that represent their ownership of liquidity in that MM strategy.
MM strategy owners and protocol teams of the underlying trading pairs, if needed, can use those tokens to provide extra incentives, or “bribes”, outside Phezzan Protocol. This essentially will create Phezzan Wars, much like Curve Wars.
May the best MM strategies win.
The natural question would be, as an LP, how do I know those MM strategy owners will not run away with my capital, change the Profit Sharing Mechanism overnight to their favor, or run some really risky strategies so they may earn a lot without losing a lot.
MM strategy owners cannot run away with LPs’ assets.
Phezzan’s on-chain vault contract will keep track of LPs’ funds associated with each MM strategy. The MM strategy can use LPs’ funds associated with their addresses to make markets, but can’t withdraw assets from the vault.
If a hostile hacker changes the code of an MM strategy, Phezzan’s backend can recognize the change and disable that MM strategy from market making. The recognized MM strategy can't make markets. In the future, this process will be decentralized, and whoever successfully identifies the code compromises will be rewarded.
Changing the Profit Sharing Mechanism has consequences.
All Profit Sharing Mechanisms must be on chain, open source, and can only be changed once a month. If an MM strategy owner changes the Profit Sharing Mechanism, LPs who provided liquidity for that strategy can withdraw their liquidity within a reasonable time without any consequences, even if it’s before LPs’ unlock date.
Risky strategies are possible yet not reasonable
While Phezzan Protocol strives to democratize perpetual trading for all, providing a new LP strategy on Phezzan is by no means easy. Those who can make good MM strategies will be industry experts or aspiring young talents. Only a tiny percentage of Phezzan Protocol’s users have the knowledge and technical expertise to create MM strategies.
Although listing an MM strategy will be permissionless, nonetheless it still takes time to develop. Phezzan will introduce a fee mechanism to avoid meaningless MM strategy upload, will mark clearly whether an MM strategy is audited/open-sourced/doxxed or not, and will proactively look for unusual MM strategy behaviors.
It’s not risk free for MM strategy owners.
For MM strategy owners to gain liquidity, they need to put in some of their own capital in the beginning to prove that their MM strategies can make money. They need to spend time to develop MM strategies, pay Phezzan fees to run MM strategies, and risk their reputation.
The Phezzan team understands that there are lots of details we need to figure out and providing liquidity always has its risks. The Phezzan team will do everything possible to ensure safety of users’ funds. At the same time, please DYOR.
So why would anyone use this? What are the benefits for everyone?
For traders, the UI/UX experiences in Phezzan won’t be much different from other major CEXs or DEXs.
Because professional market makers are not committing much of their own capital, and retail LPs have a larger appetite for higher return while tolerating higher risk, MM strategy owners now have more resources to deploy on more volatile trading pairs, which will enable Phezzan to have the best liquidity for more volatile coins.
What’s more, for the blue chip coins such as BTC/ETH, gradually there will be more liquidity on Phezzan just like what happened in Uniswap, thus tighter spreads and lower slippage for traders.
That’s Democratize Perpetual Trading for All.
With Phezzan Liquidity Marketplace, now LPs can provide liquidity for an orderbook lazily.
In the long run, being an LP on Phezzan Protocol will be more profitable and predictable than LPing on AMM style or oracle style perp DEXs.
In addition, LPs may get extra incentives from MM Strategy owners and protocols outside Phezzan.
That’s Democratize Liquidity Providing for All.
In the past, only big name professional market makers could make markets in orderbooks.
With permissionless Phezzan Liquidity Marketplace, now everyone can upload their MM strategy and challenge the giants.
Just quit your job at a hedge fund, want to start your own market making business, and don’t have enough capital? Come to Phezzan Liquidity Marketplace.
Have some really good MM strategies, want to try them out, but don’t want to take too much risk with volatile trading pairs? Come to Phezzan Liquidity Marketplace.
I mean we get it. Some professional market makers will laugh at us. We are trying to challenge an old solid industry that has made lots of money in the past. Well that is what the hotel industry said about Airbnb, what the taxi industry said about Uber, and what the TradFi said about DeFi.
That’s Democratize Market Making for All.
Alongside permissionless MM strategy listing, there will be permissionless trading pair listing.
For BUIDLers, they can list their own token as a new trading pair, find some MM strategy owners to make markets for their token trading pair, and have their own perpetual trading pair, all permissionless.
That’s Democratize Perpetual Listing and Trading for All.
Thanks for reading this far. The Phezzan team understands that we still need to figure out lots of details about Phezzan Liquidity Marketplace. This article is more about starting a conversation than making a mission statement.