Breaking Down Vader: Why It Stands Head and Shoulder Above the Rest
Vader is a cutting edge liquidity protocol that is being rolled out as we speak and has already proven to be backed by a strong community of believers who have so far staked almost 70% of the circulating supply in less than 3 days. But what exactly makes these people so bullish about Vader? To understand Vader I will try to explain what a liquidity protocol is first, since not everyone in crypto is familiar with DeFi terminology. Then I will look into the features that make Vader special and in the end we will connect the dots to help realise Vader’s potential in terms of adoption.
Generally speaking, a liquidity protocol is what allows users to buy and sell tokens without having to go through a centralised exchange (CEX) like Coinbase. The utility created for end users is to make investments in new project tokens easier for all market participants regardless of where they live or what platforms they are allowed to use.
For this, three components are required: liquidity pools, liquidity providers and a protocol (algorithmic, trustless, audited). A pool is a collection of 2 assets or tokens. So for example to sell BTC for ETH we need a BTC∞ETH pool. These assets inside the pool must come from somewhere. Normally these are assets staked by liquidity providers who in return receive a fraction of the trading fees. The nature of liquidity pools is such that anyone can become a liquidity provider by staking assets there. Since there can’t be trade without liquidity, it’s clear why LPs are so essential. Lastly, we also need a protocol. In fact, if we are to put money in the pool we need to make sure first that the pool is safe, that our capital for example cannot be simply removed from the pool by a malicious third party. And once we’ve made sure the pool is safe, we must evaluate if it’s convenient for us to stake any assets there. This set of mathematical rules that regulate the entry, exit and return on capitals that go in and out of the pool is known as the protocol.
Now we can go back to Vader.
Vader is a liquidity protocol. What makes Vader particularly powerful is the value that it is able to create for DeFi users and LPs.
Native Stablecoin (USDV)
As a user looking for a liquidity protocol to trade freely, access to a stable coin is crucial. For example when I think price is facing headwinds and headed lower, I want to lock some profits in USD in order to limit my exposure to huge price swings. To do this there must be a way to sell for a stable coin. A stable coin is a coin whose purchase power is pegged to 1 USD. The most used stable coins at the moment are USDT and USDC. Current DeFi protocols provide access to these stable coins in one way or another. However, not all stable coins are the same. Some require more trust than others. USDT and USDC for example are both stable coins built through 3rd party backing. We have to trust that these stablecoins are backed because the issuers say so. For example Tether states that for every Tether minted 1USD cash or 1 USD worth of bonds enters its treasury. USDC on the other hand claims to be fully backed by cash. For every USDC in circulation there is 1 USD in their treasury. When selling our btc or eth for usdt or usdc we still have to trust that these coins are actually backed. In other words we have to trust the issuer (third party company) isn’t minting coins out of thin air. This can be the source of a lot of speculation, malicious FUD or even panic (from our side as users as well). Tether is famous in this sense, although all stable coins are under close scrutiny by regulators. As recently as last week, for example, the chair of the senate banking committee sent a letter to all stable coin issuers to provide proof of adequate backing. If we don’t want to have to trust someone then a decentralized stable coin seems to be the only way out from both a practical and legal viewpoint.
So, to go back to our initial user problem, wouldn’t it be better if for our own peace of mind instead of a third party backed stablecoin we could opt for an algorithmic stablecoin whose backing is done automatically by an algorithm that is proven to work and no human can interfere with at their will? Now this brings us to Vader’s first strong selling point, the USDV.
The USDV is Vader’s native stablecoin. The entire protocol is anchored on USDV, which is an algorithmic stablecoin that doesn’t rely on 3rd party companies or oracles but whose purchase power is maintained at 1USD by burning the protocol token VADER. This means that we don’t have to worry about what if USDV is not backed by 1USD. Market forces make sure of that through Vader’s burn to mint algorithm.
N.B. So far no VADER has been burned, which is another reason why Vader holders are extremely bullish on the token. Once USDV minting starts, the supply of Vader will start to decrease quickly.
Now you might be wondering, why should we trust this algorithm? Has anyone actually tested it? How do we know it works and the purchase power of 1USDV really remains pegged to 1USD? Solidity devs are the rocket scientists of crypto, they are highly skilled developers that program Ethereum smart contracts. Any company looking to hire one would have to spend top dollars and would still struggle to find them. There are 7 Solidity developers in the Vader team as of now. Still, you don’t have to trust them. And this is why I love Vader, because what they have done is take/borrow what has been shown to work in other protocols and integrate it in Vader rather than try to re-invent the wheel themselves which often in crypto leads to cul de sacs where a lot of resources are burned.
This specific burn to mint stable coin mechanism has been proven to work with LUNA, which is burned to maintain the purchase power of its stablecoin UST. And case in point, UST has been the fastest growing stablecoin so far.
Liquidity Pools and AMM
For trade to occur through a liquidity protocol, aside from liquidity pools, a piece of algorithm known as AMM is required. What the AMM does, basically, is to make sure buyers or sellers get the best possible price for the asset they are trying to buy or sell. At the same time the AMM has to make sure liquidity providers get a fair fee for the liquidity they provide, and (ideally) that they are rewarded for any extra risks incurred when markets become particularly volatile. Therefore a lot of incentives have to be aligned for this to work smoothly with continuity.
Without liquidity there is no trade, so LPs are crucial and we need incentives to keep them. Attracting more LPs leads to better average user experience since more liquidity means that traders get better prices and less slippage. Slippage is basically how price changes as you increase the size of your trade. For example, in real life, if you’re a construction company and want to sell a single apartment you could probably sell them at say $1k/sqm. But if you wanted to sell the entire building block at once then you would probably have to settle for a lower price, because there isn’t enough liquidity among buyers to buy all the apartments at $1k/sqm at that specific point in time. Now the same happens with crypto, if you want to sell or buy a huge amount of tokens in a pool at once then after a certain size for every additional unit, price change would get steeper and steeper.
Slippage reflects how fast the price slips away from the current market price as the size of the trade increases. The best liquidity protocols offer the least amount of slippage. To address this, instead of separate liquidity pools, Vader uses a continuous liquidity pool (CLP) via its stable coin USDV. This ensures minimum slippage for all the pairs using Vader as it creates a common base rather than many fragmented pools.
One of the main challenges for any liquidity protocol then is to keep its liquidity. In fact many LPs may join early on when the protocol is liquidity hungry and offers great returns, but then quickly leave as other new protocols are launched. This behavior was quantified by Nansen. In an analysis released last June they found that 42% of farmers that enter the farm/pool on the day it launches, leave in the next 24h. If liquidity flees then slippage gets worse, more slippage means poorer user experience and eventually less and less users. So why shouldn’t this happen with Vader?
Because Vader uses protocol owned liquidity (POL). For this, Vader is implementing bond sales (to be released in Q4 2021). Vader’s POL will come from the sale of big chunks of Vader for a discounted price in exchange for liquidity (ETH, BTC etc) that will then be locked in the protocol. This means practically that a good chunk of Vader’s liquidity will not be coming from individual LPs, which as Nansen found is 42% likely to leave within 24h. Instead, a good portion of the liquidity will be protocol owned, acquired through bonds, and cannot leave Vader.
The POL system has also been successfully experimented in DeFi, and albeit being a very recent innovation, it has already proven to be very powerful in ensuring sticky liquidity. As result, contrary to other liquidity protocols in Vader the risk of flash in the pan liquidity is basically null as the bulk of it will be owned by the protocol itself. This should ensure a consistently good user experience regardless of the behaviour of early LPs.
LPs are Kings
Despite its non dependence on LPs, Vader still offers very strong incentives to make sure the liquidity fraction provided by private LPs is as sticky as possible. It does this by addressing the impermanent loss problem and by offering risk adjusted fees.
Normally, when an LP decides to deposit a pair in a given pool, for example ETH <> USDT, he has to deposit the same amount nominated in USD of both coins, in this case ETH and USDT. Let’s say for example the LP deposits today 1 ETH <> 4180 USDT. The pool rewards the LP with their token, in the meantime however the price of one of the assets varies. In this case, as the price of ETH goes up and down, as the pool’s AMM tries to offer the best price possible for each trade, the composition of the pool changes. This is a complex process, but the reason it matters is that if when the LP decides to withdraw their liquidity the prices of the underlying tokens have changed then the amount of tokens they get back, in USD, can be lower or much lower than what they initially put in the pool. This is known as impermanent loss. To get an idea of the amount of money that the LP can lose, let’s calculate impermanent loss for a scenario where the price of ETH is $4180 when the LP stakes the coins and $10000 when the LP unstakes them. For the math we will use this Uniswap IL calculator:
As shown above, if when the LP unstakes his tokens the price of ETH has reached $10000, then the LP loses 8.81% compared to how much he would have if he had just held the tokens. On Vader these losses don’t happen and LPs always get back the same amount in USD they would have if they had just hodled the coins.
In addition to ILP Vader also has slip based fees, this means that if traders want to take particularly big trades as they compete for market opportunities, Vader turns this risk appetite into more profits for liquidity providers as the fees automatically increase for higher slippage trades. This ensures that liquidity providers do not earn a flat fee regardless of market conditions but stand to earn more during volatile times when liquidity is harder to come by.
Now that we have shed light on all the pieces of the Vader puzzle, it should be easier to see the full picture. Vader is a liquidity protocol with very strong liquidity incentives that will allow it to quickly climb up in terms of market share and compete for market share with established alternatives like Sushi and Uniswap. Current alternatives bear much more risk both for users (because they have no POL which means higher slippage or rug pull risk) and for LPs (because they have no ILP and no slip based fees). As result, with the full launch of the protocol this month and with the start of bond sales I foresee some tectonic shifts as result of which critical masses of users and LPs will slowly slide towards Vader.
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