The Definitive Guide to VirtuSwap Protocol

May 17, 2023

In conclusion

Decentralized exchanges (DEXes) are the holy grail of DeFi. This 0-to-1 DeFi innovation still remains one of the most instrumental pillars of the DeFi economy.

While they are the fuel that powers the engine of DeFi, they are replete with problems of their own. Most of these problems have already been discussed in detail by some of the gigabrains of our industry, but there is one pernicious problem that hurts traders and LPs alike that often goes overlooked. Let’s understand what that problem is and also how one of the most innovative solutions in DeFi is solving it. 

You might have noticed that when you are trading between the most commonly known assets (such as ETH, USDT, DAI, WBTC and so on), it is pretty straightforward. You can go to your favorite DEX and simply place the order and boom… you are done. But when you are trading assets that are outside the top five most popular coins, sometimes you need to swap between a common asset to get the one you’re looking for i.e., you need to trade A for B and then trade B for C to finally get the final asset. This is known as…

Let’s assume that you want to trade your LINK to WETH but no such pool exists. But there is a pool of LINK and USDC and a separate pool of  USDC and WETH. So, in the first step you exchange your LINK for USDC. And then you carry out the rest of the trade to get your WETH. However, since this process requires you to trade across three assets, you end up paying the trading fee twice, the gas fee twice, and also losing on price impact twice. In markets with lower liquidity, that price impact cost will be even higher.

How often does this happen? Turns out, over 20% of all the volume on DEXes involves indirect trades involving assets outside the top 5. Think of all the hot new projects, all the fiery airdrops and meme coins. Whenever you trade those, you are very likely to go triangular and lose a lot of money on the way. As a matter of fact, triangular trading results in half a billion dollars in annual losses on Ethereum alone.

VirtuSwap is here to solve this problem. As Curve dramatically improved the trading for stablecoin pairs, VirtuSwap does the same for all assets outside the top 5 biggest coins, essentially for 99 per cent of all coins.

The chart below shows the distribution of total DEX volume between three trading segments, and the best DEX technology to serve that segment. It is clear that VirtuSwap’s total addressable market is huge and rivals that of Curve.

Now, let’s add another entity to this mix. The LP. The darling of DEXes. LPs take significant market risks by providing their liquidity to DEXes to facilitate seamless trading between two assets. Like you, they suffer quite a bit. Let’s understand how. 

As an LP, what could you possibly want more of? Yield. But what do you get less of? Yield. A bit of a paradox isn’t it? You provide liquidity to one of the most crucial aspects of crypto and yet you suffer from all kinds of losses. Impermanent loss, MEV front-running and sandwich attacks, and more. Also, LPs in smaller pools don’t receive many protocol rewards and not much in terms of fees, making their position even more precarious.

Does all this not make your blood boil? You could be an LP. You could be a trader. You could be both. Imagine paying redundant fees and getting low returns for the trades you want to make. 

Well, before you kill us for holding the solution so long, let us finally present it to you.

Enter VirtuSwap

VirtuSwap protocol aims to solve the existing problems with DEXes by offering traders the ability to trade assets outside the top 5 with much-reduced trading costs  (made possible by a revolutionary financial technology involving reserve-based virtual pools), along with offering LPs significantly higher returns.

To say VirtuSwap is the panacea to all DEX-related problems in crypto is too far a stretch that we won’t make - as we are bound by humility. But it wouldn’t be remiss to say that it solves an acute problem for a vast segment of the crypto trading market. Let us explain.

VirtuSwap relies on a novel pool architecture, based on reserve-powered virtual liquidity pools. The protocol extends the original two-asset AMM pool concept by allowing pools to receive not just one of their two native tokens, but a bunch of other ‘reserve’ tokens as well. Put simply, imagine a regular Uniswap V2 liquidity pool, but now in addition to the two main assets, there are also several “safe deposit boxes” for different assets attached to the pool that help to make any indirect trade feel like a direct one. Let’s understand this through an example. 

  • Let’s say someone wants to trade their LINK for WETH but no such pool exists. 
  • The user would then have to trade their LINK for USDC in the LINK-USDC pool and then trade their USDC for WETH in the USDC-WETH pool. 
  • Assume that the USDC-WETH pool has 1,000,000 USDC and 500 WETH. 
  • Assume also that there exists a LINK/USDC pool, consisting of 500,000 USDC and 80,000 LINK.
  • Now let’s assume that the trader in question wants to get WETH for 1,000 LINK. 
  • If the user goes to a DEX such as Uniswap, they will trade 1,000 LINK for USDC in the first pool - this would mean she would need to pay the trading costs in this first transaction. Now to further trade her USDC for WETH, the user would need to spend additional trading fee while suffering additional price impact. This would mean the user would pay all the trading costs twice, leading to considerable losses on the USDC they finally get. Let’s also not forget that the user would need to pay the gas cost twice for these transactions, which may be very significant, especially on Ethereum.

Now, on VirtuSwap this trade looks different on the back-end but it is exactly the same as any DEX on the front end for the user. 

On VirtuSwap, instead of using two pools, a single virtual LINK-WETH pool is constructed from the LINK-USDC and USDC-WETH pools, and the trade is executed against that virtual pool. This virtual pool happens to consist in this case of 80,000 LINK and 250 WETH (the computation involves triangulation of the two pools discussed above.) The actual transaction will see the user sending 1,000 LINK to a reserve of USDC-WETH pool and receiving WETH from that pool. Since the trader only needs to perform one transaction on VirtuSwap, she does not need to pay twice the transaction costs. It is estimated that savings on VirtuSwap can range between 35% and 50% depending on the size of the relevant pools.

How VirtuSwap attempts to reduce losses to MEV

There are three entities that are often involved in the running of an AMM. 

  • On the supply side are the liquidity providers (LPs) who provide the crucial liquidity to fuel the birth of these DEXes. 
  • On the demand side are the traders who are trading assets against these liquidity pools. 
  • The third - and perhaps also one of the most pertinent entities - the arbitrageurs (MEV bots) - who are responsible for maintaining the price peg between two assets.

The biggest profits in AMMs are usually taken by arbitrageurs who help ensure pricing efficiency on DEXes - in relation to other exchanges. These profits, made at the expense of LPs, are basically zero-risk. VirtuSwap solves this problem partially by leaving less money on the table for arbitrageurs to pick up.

This is because when traders are swapping their assets on VirtuSwap, only one side of the pool (i.e., one asset) gets affected as opposed to both assets getting affected. Let’s understand this through another example of a trade. 

Let’s assume a user sells 10,000 LINK to the LINK-USDC pool, in order to sell the resulting USDC into the USDC-WETH pool. Both pools will be imbalanced for two reasons: The amount of LINK in the first pool has increased, and the amount of USDC has decreased; similarly, the amount of USDC in the second pool has increased and the amount of WETH has decreased. 

However, when the trade is executed on VirtuSwap the trader deposits 10,000 LINK into the reserve of USDC-WETH pool. The reserves cannot be part of MEV transactions. Since only one side of only one pool is affected (the amount of WETH in the USDC-WETH pool has decreased), in this case, the gain by an arbitrageur is much smaller. As a result, the loss for the LP is significantly reduced.

Now, you can rejoice at the reduced profits that an arbitrageur makes in this case; but the truth is that the additional profit for the LPs does come with a risk.

With VirtuSwap, in addition to the two native assets in the pool, LPs also agree to hold (albeit temporarily) a certain amount of different reserve assets, exposing the LP to price variations of those. This risk is mitigated as follows:

  1. First, since the tokens to be added to these reserve pools are pre-approved by the protocol/DAO, only the most established/well-known ones are considered for the pool. 
  2. The second risk mitigation is limiting the value of the pool’s reserve assets in proportion to the pool’s native assets. This “proportion” of balancing is known as the reserve ratio and is capped at 2%, thereby reducing the price impact that LPs might have. 
  3. The third way to reduce risk is  by exchanging the pool’s reserves whenever that is feasible. These reserves happen whenever there is a trade that triggers them. For instance, let’s assume that USDC is deposited in the wstETH/stETH pool. In another trade, wstETH was exchanged for USDC. In this case, the USDC held as reserve in the first pool will be transferred over to the second pool. And the wstETH held in reserve in the second pool will be transferred over to the first pool (where it was being demanded). Thus, both pools will get rid of the reserve assets and receive their respective native assets. These reserves are exchanged using a single indirect implied exchange rate between the two reserves. This is a costless transaction. 
  4. The fourth way is used if none of the above work - which is to sell the reserve of one of the existing pools for one of the pool’s native assets.

The great thing about VirtuSwap technology is that in return for those limited risks, the LPs are rewarded by up to five times higher fees per dollar of liquidity (as a result of financial engineering above, as well as AI-best liquidity optimization, as discussed below), making liquidity provision on VirtuSwap a no-brainer.

VirtuSwap Minerva, or how to make the most from LPing

One of the primary reasons why VirtuSwap excels at what it does is by increasing the coordination and cooperation among pools. Since most pools are virtually connected to each other, they are all working towards the fulfilment of trades - as opposed to operating totally on their own.

And to ensure that the LPs get the maximum value from provisioning their liquidity to the pools on VirtuSwap - while serving the largest possible trading volumes, the protocol has introduced the Minerva AI Liquidity Optimization Engine.

Minerva offers maximal value for LPs and traders by optimizing liquidity based on its predictive model of future trading activity at the pair level. It works on a “per-epoch” basis which looks something like this:

  1. It selects the assets that need to be supported on VirtuSwap based on its prediction of top assets that are being traded on major DEXes - based on data from the previous epochs.
  2. For every epoch, the Minerva engine receives information on the expected trades in the upcoming epoch. It then calculates the optimum configuration of VirtuSwap pools in order to maximize trading volumes and LP fees received by VirtuSwap LPs.

Initially, Minerva will be centralized, but VirtuSwap is working to make it a fully decentralized AI engine which will eventually optimize not only VirtuSwap liquidity but liquidity on other DEXes as well.

The future for VirtuSwap 

VirtuSwap is offering a solution for a very large and neglected segment of DEXes, specifically - trading in all the assets outside of the top 5 most popular ones. Many of those assets belong to new and exciting projects that bring in new users, attract institutional and private investors and generate large amounts of volume. The amazing pace of innovation in our space holds a firm promise that the number of such projects will continue to grow, and together with it the need for VirtuSwap technology.

This puts a lot of conviction in the project given that it solves a pertinent problem.

In their seed round, their prominent investors included GSR and Jane Street, as well as crypto native funds such as Sharding Capital and Vista Labs, and founders and Head of DeFi of Polygon.

Incentivized Testnets

VirtuSwap had their first incentivized testnet in November 2022 where they offered airdrop to the first 1,000 traders and also conducted a host of other contests such as trading competitions. Their second testnet was released a month later and airdrops for virtual pool traders were also announced.

VirtuSwap has been running an incentivized testnet since November. So far, over 150,000 transactions by over 15,000 unique wallets have been performed. The testnet has been a source for continuous improvements of both the protocol and associated UI/UX.

VirtuSwap tokenomics

The VirtuSwap protocol has two tokens:

  • VRSW: which is the native token of the protocol
  • gVRSW: which is the governance token of the protocol

The total number of VRSW tokens that will ever be minted is 1,000,000,000 VRSW tokens, with the given allocation.

Out of this, 600M VRSW will be released for community and growth, with 10% of those tokens being released to the DAO treasury for launch airdrops and partnerships and the remaining 50% being released over a 10-year period using a predetermined algorithm.

The fee that the protocol will accrue on the trades will flow to the LPs in proportion to the assets they’ve supplied to the pools. They will also get a boost if they stake and/or lock their $VRSW tokens. However, locking the tokens won’t be necessary to get the boost.

When users stake their VRSW tokens, they get gVRSW in return which then can be used for submitting governance proposals and, overall, participating in the DAO-related activities. For more details on the tokenomics, reference their in-depth breakdown here

VirtuSwap Mainnet Launch 

VirtuSwap protocol will launch on Polygon PoS mainnet at the end of May, 2023. The protocol will perform airdrops of their tokens to users who have been 1) engaging in indirect trades on Ethereum and Polygon protocols and/or 2) providing liquidity to pools involving 99% assets on Ethereum or Polygon. By participating in the airdrop, users can discover how much they could have saved on previous trades if they used VirtuSwap.

Keep your eyes peeled on their Twitter for real-time updates on the precise launch date.

And remember, 10,000,000 $VRSW tokens have been set aside for pre-launch airdrops

VirtuSwap DAO

VirtuSwap protocol aims to transition into a DAO, true to the ethos of the decentralized ecosystem. The decisions that the DAO will make will fall under:

  • Ownership decisions: these are the decisions that will determine governance schemes, funding proposals, and more. Initially, there will be high barriers to entry for participants who will make these decisions.
  • Parameter decisions: These are the decisions that will affect changes to the protocol, such as pool fees and the assets that are accepted as pool reserves.

The other core component to their DAO structure is the emergencyDAO, which will be a council that will be put in place to make emergency decisions. Other decisions such as allocating incentives for various pools and so on.

Concluding Thoughts 

In an analysis conducted by the VirtuSwap team, they found that out of the annual DEX trading volume of $250Billion (excluding bots), over 20% or over $50 Billion volume is traded between assets outside the top 5. This implies that VirtuSwap can help the entire ecosystem by letting users trade between any assets of their choosing without ever needing to rely on liquidity. 

VirtuSwap offers excellent benefits - up to 50% reduction in costs for traders, and up to 400% (yes, five times) higher returns on the money for LPs. The project’s total addressable market is similar to that of Curve’s.

The project is backed by some of the brightest minds in the industry. It has a huge potential for being at the center of the entire DeFi ecosystem! 

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