As we approach launch in the coming weeks, it’s finally time to introduce Button Swap, a new decentralized exchange fit for rebasing and reward-bearing assets.
It’s no secret that rebasing assets create new challenges and opportunities across DeFi. One of these challenges came apparent to us in DeFi summer: the predictable losses that liquidity providers (LPs) suffer during rebasing events. This problem has never been more important than it is today with the top rebasing asset, Lido’s stETH surpassing 6.44M ETH in deposits ($12B USD):
Ethereum’s successful merge and protocols enabling withdrawals have greatly reduced the risk of these assets. As a result, the liquid staking derivative is taking the industry by storm, with some calling for an “LSD Summer.” Whether it’s Lido’s rebasing mechanism or Rocketpool’s increasing exchange rate, each of these LSDs accumulate rewards. The issue is that on existing DEXs, these rewards are leaked to arbitrage. Button Swap gives LPs comfort in knowing these rewards are safe.
The AMM Problem for Liquid Staking Derivatives
When designing AMMs, there are many trade-offs. So far, most builders have not provided the necessary provisions for Liquid Staking Derivatives in their code. Uniswap warns of the issues around being a Liquidity Provider (LP) for rebasing tokens in their documentation. Some have created alternative mechanisms, but so far have fallen short of solving one main problem: rebasing and reward-bearing events leading to predictable losses for LPs.
An Expensive Inefficiency
While it’s been glossed over to date, this is in reality a major problem – and presents a significant challenge to increasing the liquidity of these assets. Today's AMMs misprice the swap ratio between the two assets after a rebase event. Said another way, the marginal price incorrectly changes. This logic is also applicable to reward-bearing tokens like Rocketpool's rETH.
To see what we mean, consider what happens to the marginal price on current AMMs when an asset positively rebases 20%:
As shown above, existing AMMs think that the asset is getting cheaper. A mispriced swap ratio creates an arbitrage opportunity. Traders can take advantage of the mispriced pair, extracting value out of the pool that would otherwise be owned by LPs. This leads to predictable losses for liquidity providers. To counter this, protocols provide LPs with additional incentives, such as liquidity rewards, that serve to compensate for these losses.
Button Swap Solves This
Button Swap doesn’t solve for every type of impermanent loss, but it does solve for a specific type of loss. The loss that LPs incur from reward or token accrual. On Button Swap, rebase tokens do not flow directly into the active liquidity pools. Rather, new tokens from a positive rebase flow into ‘reservoirs’ representing inactive liquidity owned by LPs. This allows pools to maintain the marginal price between two assets. This is true for reward-bearing tokens and rebasing tokens.
Below is a diagram showing a 20% positive rebase on Button Swap:
As you can see, the marginal price (swap ratio) stays consistent, 1 ETH = 1 prETH. Rather than the value leaking from the pool, it flows into the reservoir. Later on, this value either flows into an active liquidity pool, or is redeemed by LPs.
Button Swap’s design is ideal for the liquid staking market, along with other rebasing assets like Ampleforth, appreciating collateral tokens like Aave aTokens or Compound’s ctokens, and reward tokens like ShapeShift’s FOXy. Button Swap also provides an opportunity for incentives to serve as lucrative rewards, rather than a way to mitigate expected losses.