[UNI] Collateral Onboarding Risk Evaluation

Legal Disclaimer: This communication is provided for information purposes only. This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but Maker has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any digital assets and the use of finance-related terminology are for illustrative purposes only , and do not constitute any recommendation for any action or an offer to provide investment advisory services. This content is not directed at nor intended for use by the MakerDAO community (“MakerDAO”), and may not under any circumstances be relied upon when making a decision to purchase any other digital asset referenced herein. The digital assets referenced herein currently face an uncertain regulatory landscape in not only the United States but also in many foreign jurisdictions, including but not limited to the UK, European Union, Singapore, Korea, Japan and China. The legal and regulatory risks inherent in referenced digital assets are not the subject of this content . For guidance regarding the possibility of said risks, one should consult with his or her own appropriate legal and/or regulatory counsel. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any decision. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Outline

  1. Summary Proposed Risk Parameters
  2. Overview
  3. Metrics and Analysis
  4. Risk Parameters

Summary Proposed Risk Parameters

Risk Premium: 3%
Liquidation Ratio: 175%
Debt Ceiling: 15 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 500 Dai

Overview

Protocol Summary

From the documentation:
Uniswap V2 is an automated liquidity protocol powered by a constant product formula and implemented in a system of non-upgradeable smart contracts on the Ethereum blockchain. It obviates the need for trusted intermediaries, prioritizing decentralization, censorship resistance, and security. Uniswap is open-source software licensed under the GPL.

Each Uniswap smart contract, or pair, manages a liquidity pool made up of reserves of two ERC20 tokens.

Anyone can become a liquidity provider for a pool by depositing an equivalent value of each underlying token in return for pool tokens. These tokens track pro-rata LP shares of the total reserves, and can be redeemed for the underlying assets at any time.

Pairs act as automated market makers, standing ready to accept one token for the other as long as the “constant product” formula is preserved. This formula, most simply expressed as x * y = k, states that trades must not change the product (k) of a pair’s reserve balances (x and y). Because k remains unchanged from the reference frame of a trade, it is often referred to as the invariant. This formula has the desirable property that larger trades (relative to reserves) execute at exponentially worse rates than smaller ones.

In practice, Uniswap applies a 0.30% fee to trades, which is added to reserves. As a result, each trade actually increases k. This functions as a payout to LPs, which is realized when they burn their pool tokens to withdraw their portion of total reserves. In the future, this fee may be reduced to 0.25%, with the remaining 0.05% withheld as a protocol-wide charge.

Because the relative price of the two pair assets can only be changed through trading, divergences between the Uniswap price and external prices create arbitrage opportunities. This mechanism ensures that Uniswap prices always trend toward the market-clearing price.

UNI is an ERC20 token aimed for the purposes of enabling shared community ownership and a vibrant, diverse, and dedicated governance system, which will actively guide the protocol towards the future.

Tokenomics

At the time of this analysis (Nov 2019) UNI token is strictly a governance token without any yield/revenue. Its market value is based on its governance capabilities and the potential protocol fees in the future. UNI governance may enable the 0.05% protocol fee after the 180 day time lock (at earliest at end of April 2021).

At v2 launch, the protocol charge was set to 0% , and the liquidity provider fee to 0.30%. If the protocol charge is switched on, it will become 0.05% and the liquidity provider fee will be 0.25%. Therefore this action does not affect traders, but would affect the amount received by liquidity providers. Since 17 October 2020 UNI owners control the (community) treasury where protocol fees (in traded ERC20 pairs) would accumulate. The specifics of revenue distribution is yet to be determined by the UNI holders. If hypothetically all revenue from the protocol fee goes to UNI holders we could very roughly estimate a P/E ratio:

  • As of Nov 2020, average daily revenue is around 200-300mil.
  • Treasury annualized revenue: 365 * 250m * 0.05% = 45.625mil USD
  • With this estimation of revenue, a fully diluted market cap after 4 years (1B UNI), unchanged volume and many other assumptions, this would translate to a P/E ratio of 75 (using current price of 3.5 USD).

On-chain fundamentals

At time of writing the UNI token does not produce yield but might in the future - see the Protocol Summary and Tokenomics sections.

Since the initial distribution included a broad range of users or rather wallets - anyone that has ever interacted with the Uniswap protocol before Sept 1st 2020 - the token is held by a vast number of wallets.
Number of addresses currently holding UNI: 102,612

Current top holders:


The top holders are of course the vesting contracts (community treasury, team, investors, advisors). Other notable ones are also Binance and Uniswap V2 exchange.

Source of data: Etherscan

Metrics and analysis

CEX and DEX volume

With the reputation Uniswap has accumulated over the past couple of years it’s no wonder the UNI token has quickly been added to several centralized and decentralized exchanges. Among the more notable of them Binance, Huobi, Bitfinex, OkEx, Coinbase Pro and Uniswap, SushiSwap on the decentralized side. We see the most volume in UNI trading against USDT, other stablecoins or fiat, ETH and BTC.

Snapshot of top trading volume for UNI pairs on 19 Nov 2020:

Exchange Pair Volume (24h)
Binance UNI/USDT $69,031,865
Huobi Global UNI/USDT $53,671,085
OKEx UNI/USDT $30,930,611
Coinbase Pro UNI/USD $19,571,987
Uniswap V2 UNI/WETH $18,632,557
Binance UNI/BTC $13,200,750
OKEx UNI/BTC $7,702,259
Binance UNI/BUSD $3,663,511
Binance US UNI/USD $977,794
Kraken UNI/EUR $788,909

Source of data: Messari

Total traded daily volume exploded right after launch but currently holds steady at around $500 million. Here's a comparison of total volume and the most popular UNI pairs on popular centralized exchanges since genesis:

Source of data: Santiment, CryptoCompare

Uniswap V2 is the most active by far of the decentralized exchanges if we’re looking at all UNI pairs volume, followed by SushiSwap and others. We’ve added SushiSwap UNI pairs volume for comparison:

Source of data: Uniswap V2 Subgraph & SushiSwap Subgraph

Token distribution

Token allocation and issuance (genesis mid Sept 2020):

1 billion UNI have been minted at genesis and will become accessible over the course of 4 years. The initial four year allocation is as follows:

60.00% to Uniswap community members - 600,000,000 UNI

21.266% to team members and future employees with 4-year vesting - 212,660,000 UNI

18.044% to investors with 4-year vesting - 180,440,000 UNI

0.69% to advisors with 4-year vesting - 6,900,000 UNI

15% [150,000,000] of tokens were immediately available to historic users and liquidity providers and 2% [20,000,000] were distributed in the liquidity program that was ongoing from 18 September 2020 to 17 October 2020 where four of the most active pools were targeted - ETH/USDT, ETH/USDC, ETH/DAI and ETH/WBTC. Each was allocated with 5,000,000 UNI and distributed to liquidity providers over the duration of the program. The rest - 43% - is vested in the Community Treasury, which is controlled by UNI token holders.

Here’s the token distribution from genesis until today - number of addresses bucketed with amount of UNI:

Source of data: Santiment, Introducing UNI page

Supply inflation

Current circulating supply is estimated at around 215,000,000 UNI.

The Community Treasury holds 43% of the initial supply with a 4 year vesting scheme. Team, investor, and advisor UNI allocations will have tokens locked up on an identical schedule:

Year Community Treasury Team Investors Advisors total Vesting Distribution % Circulating supply
0 170,000,000
1 172,000,000 85,064,000 72,176,000 2,760,000 332,000,000 40 502,000,000
2 129,000,000 63,798,000 54,132,000 2,070,000 249,000,000 30 751,000,000
3 86,000,000 42,532,000 36,088,000 1,380,000 166,000,000 20 917,000,000
4 43,000,000 21,266,000 18,044,000 690,000 83,000,000 10 1,000,000,000
5+ perpetual +2%

The Community or Governance Treasury's purpose is to advance the protocol and the broader community by funding public goods, various grants and experiments on an ongoing basis.

After 4 years, a perpetual inflation rate of 2% will start, ensuring continued participation and contribution to Uniswap at the expense of passive UNI holders.

Source: Introducing UNI blog post, CoinGecko

Tokens on exchanges

The UNI token was quickly added to all popular centralized and decentralized exchanges and is actively traded on all venues. Binance is the most popular of the centralized exchanges among UNI traders closely followed by Uniswap V2 as the biggest of the decentralized exchanges. Although minute compared to Uniswap V2, other decentralized venues like SushiSwap and Balancer are also seeing UNI trading action. Here’s the comparison of current balances on exchanges:

Source of data: Nansen

Downside risks

As UNI has only been available since September, we have daily pullback comparison only for the last 68 days. There weren't any significant market drops (ETH) in this short timespan.

source: cryptocompare

Volatility

It has only been a little over two months since the UNI token was introduced so we're very limited with the number of trading days. We'll include all the available days to calculate volatility but we do have to take into account that any newly introduced token will show huge volatility in the first few price discovery days.

volatility scaled yearly
68 days 2.49% 232.8%

Source of data: CryptoCompare

Defi presence

Due to the nature of the Uniswap token:

  • not complex token with limited functionality and protocol's low smart contract risk
  • likely quite sophisticated holders (early defi users, liquidity providers) and significantly distributed token
  • governance token of the iconic (v1 as first completely permissionless) dapp on ethereum : strong brand name

The UNI token has immediately gained wide defi presence and is used in all major protocols.

Current (20th Nov 2020) liquidity per protocol:

Uniswap: $32m

Aave: $2.2m

Balancer: 0.6m

Compound: $45m

Cream: $3.5m

Set defi index: $5m

Sushiswap: $3.5m

Summary of notable risks or red flags

  • Uniswap V3 information (roadmap, plans) is not publicly available. We can only speculate how release will impact the UNI price (for example, short term increase in volatility)

  • AMM protocols are still (relatively) new tech, especially in combination with token governance and there could be unforeseen risk, like sudden and permanent loss of liquidity (locked capital). There seems to be a widely held belief that AMM protocols are the winner-take-all markets, however future Ethereum scaling solutions may bring order book trading dominance.

  • Efficiency of the new decentralized governance may hurt Uniswap reputation (many holders might not have much governance experience, high UNI threshold for new proposals)

  • Aggressive competition may steal liquidity from Uniswap V2 which would possibly also affect UNI price. We've seen very big shifts of liquidity between protocols, mainly lured by liquidity farming incentives.

Proposed Risk Parameters

Risk Premium: 3%
Liquidation Ratio: 175%
Debt Ceiling: 15 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 500 Dai

We used the model from the Collateral Risk Assessment Guide here. Inputs to the model are derived from trading data along with stressed input parameters. A link to our model specification with inputs and outputs can be found here. Auction parameters have been selected to mirror those for ETH.

Lead Researcher: Jernej Mlakar & Andrej Marolt

Sources

10 Likes

Looks good, thanks. Just wanted to note that the model predicts 30m maximum debt ceiling where 6% RP is proposed. 30m figure should be used as DC hard cap for MIP27 IAM DC, once implemented. I think starting with 15m DC makes sense in this current environment, although UNI is both supported at Compound and Aave already. 3% SF would position Maker somewhere in the middle.

2 Likes