Comments on Liquidity, Slippage & Arbitrage

Treasury and Tokenomics
1

NFT funds on NFTX (e.g PUNK, GLYPH, etc.) get priced based on market forces and arbitrageurs. This process is different for D1 funds and D2 funds, but the main idea is the same. Let’s consider a D1 fund like GLYPH first.

GLYPH is designed to track the floor price of the Autoglyph market. When GLYPH price deviates from the actual floor price, this creates an opportunity for arbitrageurs. There are actually four ways which a deviation can occur, depending whether it’s GLYPH that’s driving the market or Autoglyphs.

1A. GLYPH buy orders can cause GLYPH price to go above Autoglyph price floor
1B. GLYPH sell orders can cause GLYPH price to go below Autoglyph price floor.
2A. Autoglyph buy orders can cause Autoglyph floor to go above GLYPH price.
2B. Autoglyph sell orders can cause Autoglyph floor to go below GLYPH price.

These four paths to arriving at a deviation can be grouped into two final situations:

  • GLYPH > Autoglyph floor (1A & 2B)
  • GLYPH < Autoglyph floor (1B & 2A)

Keep in mind that the NFTX primary userbase is NFT fund investors and traders (i.e. people buying/selling/holding GLYPH), and not Autoglyph collectors looking for arbitrage opportunities. For this reason, it is a bigger concern if users are overpaying to buy GLYPH than if Autoglyph collectors are getting underpaid to mint GLYPH. Likewise, it is worse if GLYPH price is failing to keep up with Autoglyph price appreciation, than if Autoglyphs are failing to keep up with GLYPH appreciation.

So, things we want to avoid:

  1. GLYPH buyers overpaying for GLYPH without realizing it
  2. GLYPH price failing to keep up with Autoglyph appreciation

Problem (2) can arise if demand for Autoglyph NFTs increases faster than demand for GLYPH, or if GLYPH demand decreases faster than Autoglyph demand. Either way, since GLYPH is beginning at demand = 0, this is a very unlikely issue to have in the early months of the project. Moreover, since the solution to this problem is burning fund tokens to redeem NFTs, it is really only an issue for funds with low supply (e.g. KITTY-FOUNDER, AXIE-MYSTIC-2, and PUNK-ZOMBIE) . I have ideas for ways we can avoid this in the future, but since it is not an immediate issue I suggest we table it for the time-being and focus on problem (1), i.e. GLYPH buyers overpaying without realizing it…

What could happen when we launch funds (especially D2 funds like PUNK which are more difficult to arb) is that as people hear about them and decide to get a position, increased demand for GLYPH causes it to go above the Autoglyph floor. Right now the autoglyph floor is around 13 ETH on OpenSea (ie. the cheapest Autoglyph for instant purchase is 13 ETH), so if we get into a situation where GLYPH starts to trade above 13 ETH (e.g. 16 ETH), and someone buys GLYPH and then finds out that they could have purchased an Autoglyph for cheaper, then they are going to be pissed off, and that is a reasonable response since NFTX is supposed to be about making things easier and more accessible for less knowledgeable users. So we definitely want to avoid this.

The solution to that problem is arbitrage. If GLYPH is trading for 14 ETH and there is an Autoglyph for sale for 13 ETH, that means someone can buy that Autoglyph, use it to mint 1 GLYPH token, sell that GLYPH token for 14 ETH, and pocket 1 ETH in profits (minus gas fees). For savvy NFT traders this should be an exciting couple months with lots of money making opportunities, but even savvy NFT traders can not fill trades instantly, so it is important that we make users aware of the fact that prices can deviate from underlying markets and that it may take a day for price parity to return after large orders. However, this is not a real solution.

The real solution is for the NFTX smart contracts to automatically complete the arbitrage as part of purchases. For example, if someone wants to purchase 3.5 GLYPH and that will push the price of GLYPH significantly above the price of the cheapest autoglyph, then the smart contract can instead only sell 2.5 GLYPH and buy the other glyph directly from OpenSea and use it to mint more GLYPH for the order at a lower rate. This was my original plan for NFTX but I realized it would take awhile to finish and that we couple temporarily boost liquidity by using farming.

So, to wrap this rant up, this problem of users unknowingly overpaying for fund tokens is somewhat of a temporary problem. My plan for NFTX version 2 will be to have a frontend trading aggregator which draws on liquidity from both ERC20 markets and NFT markets, so that users never have to worry about checking NFT prices before hitting the buy button.

In the mean time, I think what’s best is that we stay aware of this issue and that we try to roll out funds one at a time, and focus on giving the most recently launched fund some added liquidity for the first few days it is live so that anyone wanting to build an early position in that fund can do so over the span of a couple days. That way everyone can prepare their stacks for farming without there being a stampede or too many upset users.

Thoughts? EDIT: I will try to follow-up later with some more comments regarding D2 funds.

1 Like
2

So rather than the buyer going off and purchasing a GLYPH for cheaper, minting it themselves and pocketing the extra 1ETH themselves, the system would do that for them and give them 1ETH more of GLYPH for the same purchase amount?

If that is version 2 for NFTX is there any timeframe on that coming?

In the meantime, could we show a visual flag against the purchase of the GLYPH on the NFTX front end to say there’s a mismatch in price against the glyph with the lowest floor price? And if that is possible would you also put a link through to that Glyph so folks could look to purchase and mint it themselves (although I assume that leads into your point below)

but even savvy NFT traders can not fill trades instantly, so it is important that we make users aware of the fact that prices can deviate from underlying markets and that it may take a day for price parity to return after large orders

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3

Thanks javery, these are good points.

So rather than the buyer going off and [… ] give them 1ETH more of GLYPH for the same purchase amount?

Yes exactly. And we could still theoretically charge a fee as well (if we want in the future).

If that is version 2 for NFTX is there any timeframe on that coming?

In terms of timeframe I cannot promise anything but I would like to have a version 2 out sometime this Spring.

Right now I am handling both the frontend and the smart contracts, but idealy we will have a full-time frontend dev in the near future that could get started on building this. Of course, I am happy to do it as well, but the earliest I could see myself getting started on a trade aggregator would be Februrary.

The idea for warnings is good to, once we have a trading aggregator. For now, most traders will just be buying/selling via Uniswap though so we will have to rely on word of mouth, documentation, blog posts, etc. to remind users that there can be potential price gaps. My hope is that ppl will make arb bots and this won’t be a big issue.