Investment Thesis: Arrakis Finance• Pablo Bartol • 12 min read
- Core vision: To become the go-to liquidity layer in web3, acting as a decentralized market-maker where users have their liquidity managed through Arrakis, and projects can create deep liquidity for their native tokens.
- Pain Point: Providing capital on Uniswap V3 can be complex for retail and/or unsophisticated LPs.
- Product & USP: Arrakis provides an Automated Liquidity Provision Management solution for Uniswap V3. Now, anyone can easily provide a single token or token pair and deposit it seamlessly into Uniswap.
- Target market:
- Arrakis V1: Retail users who provide liquidity on Univ3.
- Arrakis V2: Treasury Managers or professional traders/liquidity providers seeking advanced market-making strategies on UniV3. Vaults deployed in V2 can be public, accessible to anyone to add liquidity, or private, only accessible to whitelisted wallets.
- PALM: Protocols that want to control their native token liquidity, either governance tokens, stablecoins etc to be liquid without the need for bonding or liquidity mining.
- Revenue Model:
- Arrakis V1: 2.5% of the trading fees earned by deposited funds.
- Arrakis V2: No protocol fees.
- Arrakis PALM: 1% quarterly management fee and 50% performance fee on the trading fees earned on Uniswap that accrue to the vault manager.
- Tokenomics: Arrakis is actively working on its tokenomics.
- Arrakis V1: Other competitors are relatively small and/or no longer actively developing.
- Arrakis PALM: To some extent, Olympus PRO.
- Arrakis V1: MakerDAO uses Arrakis through Oasis, allowing users to gain 50x leverage on their DAI and become LPs on Univ3, where Arrakis manages the LP.
- Arrakis V2 and PALM: Several partnerships have been established with other leading Web3 and DeFi protocols.
An Overview of Arrakis
Arrakis acts as a decentralized market-maker where users have their liquidity managed through Arrakis, and projects can create deep liquidity for their native tokens.
AMMs (Automated Market Makers), such as Uniswap V1 or V2, distribute liquidity evenly throughout the entire bonding curve, allowing LPs to earn fees and actively participate in market making as long as prices remain between [0,inf). These price ranges cannot be modified by the LPs, allowing them to passively provide liquidity and earn trading fees generated in the pool.
Newer AMMs, particularly Uniswap V3, introduced CLMM (Concentrated Liquidity Market Makers), which allows users to choose the price range in which they want to provide liquidity. For example, if liquidity providers strongly believe that ETH-USDC will trade between $1,000 and $2,000, they can provide liquidity only in this range. Another example is for a stablecoin pair, such as DAI-USDC, where providing liquidity in the range of $0.999 to $1.001 will guarantee that the LPs' liquidity will always be used. This offers several benefits, including:
- Improved user experience for traders: liquidity is concentrated around a specific price band, resulting in less slippage when placing larger trades. In addition, having liquidity concentrated in a tight range, such as for stablecoins, makes it harder to depeg. For example, if $500M is held in the DAI-USDC in a $0.99 to $1.01 range, a large enough trade would need to be placed to significantly empty the price range and move the price.
- Customizable positions for LPs: If they provide liquidity in a tight range that attracts most of the trading activity, they may earn a higher share of fees, in theory.
However, this increased customizability for LPs comes with extra burdens to them, including:
- Position Management: LPs need to actively manage the price range of their position. Additionally, since Uniswap V3 represents the position as an NFT, users must unbind their entire position and bind it again to modify the parameters.
- Positions Rebalancing: Decide on how often they should rebalance their position. If the position moves out of range, all the assets get virtually swapped to one of the two assets in the pool. If that happens, LPs need to decide if they want to realize the impermanent loss or wait for the price to get back into their range. In the ETH-USDC example above, if ETH crashes below $1000, the position would be held solely ETH.
- Market Analysis: Having a clear view of the market and predicting price movement to capture fees in the movement.
Uniswap has revolutionized the world of DEXs with its groundbreaking concept of concentrated liquidity, which has resulted in increased capital efficiency for DEXs and higher trading fees for liquidity providers. However, it's important to note that being a successful liquidity provider in Uniswap V3 requires technical knowledge, day-to-day management, and a hands-on approach to market-making.
With Arrakis at the forefront, the protocol is making it easier than ever before to access high-quality DEX liquidity. LPs will no longer have to face increased complexity and risk when trading on Uniswap V3 - Arrakis has made it their mission to bring together the best practices for providing effective liquidity, making it publicly available and easily integrated with the rest of the DeFi landscape. This results in deeper and more reliable liquidity for a wide range of projects and use cases within the vibrant web3 ecosystem.
CrocSwap recently highlighted a real-world example of the pain points presented in the previous section.
The majority (>50%) of LP positions on the UniV3 USDC-ETH pool are providing capital outside of the active range, thus not actively market-making and not earning fees on their LP positions.
Providing capital at Uniswap V3 has proven to be a complex task for retail and unsophisticated LPs. As highlighted by Robin Fritsch’s paper, Uniswap V3 has offered better returns to LPs for stablecoin pairs. Although it may have the potential to provide better returns for more volatile pairs, picking the right liquidity strategy is not straightforward.
To address the challenges of manually managing liquidity in Uniswap V3, new protocols have emerged with "set and forget" automation tools. Arrakis is at the vanguard of this movement and aims to become to be the go-to liquidity layer on web3 by acting as a decentralized market-maker infrastructure. This allows users to let themselves, Arrakis, or other liquidity managers, manage their liquidity through the Arrakis V2 infrastructure. In turn, this also enables projects to manage and create deep liquidity for their tokens.
The proposition of Arrakis V1 is simple: users deposit the pair of tokens that form the LP in a ratio pre-defined by Arrakis, and Arrakis takes care of selecting the best LP strategy, which includes deciding the best price range and rebalancing the pool. Since Uniswap V3 vanilla doesn't have any NFTs, Arrakis can easily adjust positions without the need to close and reopen it. Furthermore, users receive ERC20 tokens that represent a share of the LP vault, making it possible to use Arrakis LP tokens as collateral or for other purposes. Additionally, since positions on Uniswap V3 don’t auto-compound fees, Arrakis will reinvest the fees earned.
The roadmap outlines two different planned releases that aim to change the business model and onboard other protocols. One release pertains to the infrastructure and the other involved the first product built on top of this infrastructure.
- Arrakis V2: aims to allow vault managers to take more complex positions within a vault, both by having multidimensional ranges and by allowing managers to provide liquidity at more than one fee tier. The rebalancing of positions can be done outside of Uniswap V3.
- Arrakis PALM (Protocol Automated Liquidity Management): is a product built on top of the V2 infrastructure. It allows protocols to bootstrap liquidity with their own tokens and increase the depth of liquidity for their token(s) over time. The protocols will be the sole providers of liquidity in the vaults while Arrakis Core acts as the vault manager, overseeing the PALM strategy. This solution is a step forward from Protocol Owned Liquidity (POL) and is expected to be more cost-effective compared to Liquidity Bonds or Liquidity Mining rewards. Uniswap V3's ability to handle a range of orders and options allows for positions that would otherwise be impossible.
The possibility to create new tokenized products on top of Arrakis is opening up new innovation opportunities, such as complex multi-position on concentrated AMMs, cross-chain strategies, auto-hedging LP positions, liquidity as a service, treasury management, and LP positions linked to lending/borrowing or options markets. Arrakis also increases composability by converting LP positions from ERC-721s into G-UNI tokens, which are ERC-20s and make it easier for other protocols to develop on Uniswap V3, as ERC-20s are far more composable than their NFT counterparty.
Target Market and Participants
The target market of Arrakis is, at this point in time, exclusively Uniswap V3 LPs, as approximately 40% to 60% of all daily DEX volume happens on Uniswap V3. Currently, the next relevant DEX, which is Pancakeswap, does not use CLMMs that Arrakis could integrate into.
Arrakis reached its peak with $1.83 billion in TVL as of 28th July 2022. At the same time, Uniswap V3 had roughly $4.03 billion in TVL, implying that Arrakis held roughly 45% of the total liquidity on Uniswap V3.
Liquidity providers earn trading fees by providing liquidity and avoiding the need to actively manage their position on Uniswap V3, making it a convenient solution for those without the time or expertise to do so.
Vault Deployer is responsible for generating the vault, which entails creating the smart contract logic, defining the tokens, fee tier on Uniswap V3, fee earned by the manager, and initial vault settings. This could either be an individual or a specific project that seeks to improve the liquidity of their token.
Vault Managers are specified by the vault deployer and they are responsible for actively managing liquidity and setting the vault strategy. Managers can range from an individual who uses Arrakis for gas-optimization reasons, projects who want to control the liquidity of their token, or professional managers that want to manage liquidity for others. It can also be executed via a smart contract, enabling fully trustless vaults to be created.
At Arrakis, anyone can be a manager both on V1 and V2. In Arrakis V1, the focus was on retail and most of the vaults were set and managed by Arrakis. However, with the launch of Arrakis V2 and PALM, the target customer segment shifts from retail to other Web3 (DeFi) projects. This leads to the following possibilities:
- The protocol, as the owner of liquidity, can manage the vault and set the liquidity curve at the risk of acting as its own market maker.
- A third-party, such as Yearn or an anonymous manager, can manage the vault, requiring trust in the third party and a portion of the fees earned through Uniswap V3 are likely to be shared.
- Arrakis can manage the vault, which is suitable for stablecoins like USDC and DAI where active management is not required.
There is and always will be a trust relationship between depositors (LPs) and the vault managers. LPs have to trust that the vault manager will act in their best interest and execute the best possible strategy. The strategy can be on-chain or off-chain and is completely dependent on the manager. Trust-minimized vaults can be created due to the possibility of creating public trustless vaults that are managed by a smart contract and not by an individual manager.
Arrakis is currently developing its strategies, and its revenue model primarily relies on management and performance fees. This fee structure ensures that Arrakis' team is aligned with the interests of its users as they have the incentive to generate higher returns for their clients in V1 and PALM. By prioritizing the delivery of a robust infrastructure layer, Arrakis can attract and retain more capital, which can eventually lead to business growth and increased revenue.
As of February 2023, the only fee on Arrakis is a 2.5% performance fee taken from the trading fees earned by deposited funds. However, vault managers have the option to increase this fee up to 9.75%, receiving a maximum of 7.25% after Arrakis takes its share. In the case of rebalancing fees in V1, they are covered by Arrakis, although this is unlikely to occur given that Arrakis would not want to realize potential losses if LPs are underwater.
Arrakis V2 and PALM
Arrakis’ upcoming release will introduce two new business models:
- V2: There will be no protocol fees.
- PALM: It will implement a 1% management and a 50% performance fee structure. The performance fee will be taken from the trading fees earned by the manager on Uniswap.
What if a vault is not profitable?
- V1 & V2: Only the LPs will take the loss. The loss can be realized if the pool's parameters are changed, i.e., the pool is rebalanced. That's why some pools may be outside the active range, as the manager expects the IL to revert. For example, the agEUR/USDC vault (as per the Dune chart), the third biggest vault as of February 2023, was outside the active range during September and October 2022, and the LP is not earning fees. In this specific case, Arrakis, the manager of the vault, decided not to rebalance the pool to avoid realizing the IL.
- PALM: Technically, the project (which is also the LP) will take the loss. However, the key point here is that the project might want to realize the loss, depending on the circumstances. If a position in Uniswap V3 uses a very narrow price range, it can act as a buy/sell limit order. For example, suppose a project’s treasury provides 95% of its native token and 5% of ETH, USDC, or another token pair. In that case, as the pool fluctuates, the LP becomes 50/50 balanced. While it can be perceived as a loss given the treasury has sold its native token for another token, it also is a positive opportunity for the said project to realize the loss and diversify the treasury.
Currently, the team is working to release its tokenomics, including the distribution and economic model of SPICE. The aim is to introduce increased transparency in governance and provide new incentives for the protocol's users. While the exact details have not yet been made public, the team is working diligently to bring this information to light.
The roots of Arrakis can be traced back to the Gelato Network, a web3 automation protocol founded in 2019 and deployed on Ethereum in 2020. In 2021, Gelato introduced G-UNI, an ERC20 token that streamlines Uniswap V3 liquidity provision management. With its popularity growing quickly in the DeFi space, the Gelato team decided to spin it out and rebrand it as Arrakis Finance in March 2022. This was made possible through a governance vote by GEL token holders, resulting in the creation of Arrakis DAO and the SPICE token.
At Arrakis V1, the deployment of vaults is done by Arrakis itself. However, given that 98% of funds come from levered MakerDAO G-UNI pools, it is crucial to establish new and diverse partnerships to ensure long-term sustainability.
Several protocols had established formal relationships with Arrakis V2, including:
- V2 "Launch Partners": Threshold, Paladin, and Reaper.
- PALM: Paladin, ByteMasons, Fuse, and HOPR will use it as a way to manage their treasury holdings and enhance their on-chain liquidity.
Integrating other concentrated liquidity AMMs is in our view, not a priority, for now, given that 40% to 60% of the DEX volume happens on Uniswap, with a volume ranging from $0.5 billion to $2.5 billion over the past months. Within Uniswap, 80% of the volume currently takes place on Ethereum, with some traction gained on Arbitrum, Optimism, and Polygon.
Curve, despite being high on the DEX Volume leader boards, does not need a liquidity manager integration. On the other hand, some protocols like Trader Joe, which has yet to launch its v2 concentrated liquidity update, are way past their prime with daily volumes from $5M to $10M. Orcasol has had an average of $20M in daily volume throughout September 2022, while Lifinity had an average of $4M. CrocSwap as of yet had not been launched.
Forming partnerships with other DeFi protocols can be a smart strategy for Arrakis to expand its offerings, expand its user base and attract more capital. These partnerships can also improve Arrakis' competitive position in the market and increase its visibility as the leading market-making infrastructure for web3.
The competition in the Uniswap V3 liquidity management space is limited, with several players struggling to achieve a critical mass of market share. This competition can be split into two categories: pure Uniswap V3 liquidity managers, such as Charm, Gamma, Lixir, and Unipilot, and protocols that have exposure to Uniswap V3 LPs, like Aloe.
Charm is a liquidity manager on Uniswap V3 that automatically rebalances trading pairs to guarantee they stay on the range, but currently only supports three vaults (wBTC/USDC, ETH/USDC, and ETH/USDT). Its TVL has steadily declined through 2022 and currently hovers around $1 million. As evidenced by the data presented here, the performance has been far from ideal and the vaults are sitting slightly underwater.
Gamma is an active liquidity manager on Uniswap V3 and Quickswap on a wide range of assets. It implements three different strategies based on the nature of the LP tokens, providing liquidity in a wide, narrow, or “peg-asset” range. Its TVL is roughly $18 million, mostly on Quickswap and it is live on Ethereum, Polygon, Arbitrum, Optimism, and Celo. The team is responsible for the development of the strategies and has not yet built a dashboard to display the profitability of the strategies implemented.
Lixir previously offered Uniswap V3 liquidity management but pivoted away from it in March 2022 to focus on POL management. It seems that the protocol has gone out of business, since their last Twitter update was over a year ago and their current TVL is around $40K.
Unipilot is a Uniswap V3 liquidity manager that concentrates on the current trading price. It takes a 20% cut of all fees earned on the protocol. The strategies are set by the team, usually revolving around providing liquidity in a wide or narrow range. Currently, live on Ethereum and Polygon. During December 2022 the ETH/USDC vaults seemed to outperform simply holding the assets, as shown here.
Aloe launched in January 2023 on Optimism. It allows market makers (Uniswap LPs) to access margin (up to 20x) on their Uniswap V3 positions. Market makers will borrow capital and pay interest on their loans, giving users exposure to Uniswap V3 without having to become LPs themselves. More information is available here.
Arrakis aims to be an essential infrastructure piece and become the go-to choice for managing Uniswap V3 liquidity positions, where third parties can select the best strategies based on their objectives and market perspectives. Unlike its competitors, Arrakis is seeking to ensure long-term revenue stability by gaining a large enough market share, which is something that its competitors have been unable to achieve. Additionally, while some of its competitors claim to use state-of-the-art methodologies, their track record shows that historically the performance of their products is questionable.
Protocols like Convex and those involved in the "Curve Wars" could also be considered liquidity managers, because Convex has the ability to change the CRV gauges and direct CRV rewards to pools, which could lead to deeper liquidity for protocols on their tokens and better returns for LPs. Despite operating only on top of Curve, Convex and some other projects have still managed to capture a large enough market share to ensure their success. Although, Arrakis has limited its integration to Uniswap V3, this doesn't necessarily mean it won't be successful, as seen by the example above. In fact, by focusing on a single ecosystem, Arrakis can allocate all its resources to improving liquidity provision on Uniswap V3.
The Arrakis team recently released V2 and PALM to enable vault managers to take more complex positions in the vault and protocols to bootstrap liquidity with their tokens, gradually increasing liquidity, respectively. The team is actively seeking clients and partnerships for these new features.
In the long term, the team intends to enhance the capital efficiency of the protocol through several improvements. Some examples include:
- Tooling: Treasury management tooling built on top of Arrakis.
- Volatility DEXs: Where volatility traders borrow and re-arrange their Uniswap V3 positions.
- Protocol Controlled Liquidity: Protocols can dictate where their tokens trade by changing the Uniswap ranges.
- Toxic order-flow strategies: Migrating liquidity from low-fee to high-fee during toxic order-flow to protect LPs, for example.
- Permissionless Vaults: Creating permissionless and trustless market-making vaults.
- Lending/Borrowing: Developing a lending and borrowing platform that uses Uniswap V3 positions represented as ERC-20.
- Yield Aggregator: Integrating yield aggregators, like Yearn, for AMMs.
Arrakis has been able to position itself firmly in the market by addressing the challenges faced by many participants in the Uniswap V3 ecosystem, which is the largest CLMM and DEX. With a focus on actively managing liquidity positions, Arrakis stands out among its competitors who are relatively small and have a questionable track record of LP management.
While the current Arrakis V1 relies heavily on the DAI/USDC trading pairs, the upcoming V2 and PALM updates will reduce this reliance, attract new users, and diversify revenue streams, making Arrakis a promising investment opportunity.