CCC: Cryptocurrency Course slide set

## Definitions
> Liquidity: the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price. The most liquid asset of all is cash itself.  ([ref](https://www.investopedia.com/terms/l/liquidity.asp))

> Liquidity pool: a pool of tokens that are locked by a smart contract ([ref](https://cryptodefinitions.com/dictionary/liquidity-pool/))

## Order Book Method
- To buy: state how much you want to buy at the current market price, and put in an order ("market order")
  - Possibility an upper limit ("limit order")
- Then give your money to the centralized exchange
- The exchange tries to pair up your order to buy with somebody who is selling and willing to accept those prices/amounts
  - Really both are just exchanging commodities
- This occurs on a *Centralized Exchange* (CEX)

## Order Book Method
[![](https://upload.wikimedia.org/wikipedia/commons/1/10/Order_Book%2C_depth_of_market.jpg)](https://upload.wikimedia.org/wikipedia/commons/1/10/Order_Book%2C_depth_of_market.jpg)
- Example: [gate.io](https://www.gate.io/)
  - See the USDT orders for [BTC](https://www.gate.io/trade/BTC_USDT), [ETH](https://www.gate.io/trade/ETH_USDT), and [RVN](https://www.gate.io/trade/RVN_USDT)
  - The red values are those that are selling {BTC,ETH,RVN} for USDT
  - The green values are those that are buying {BTC,ETH,RVN} for USDT
- Discuss "makers" and "takers"

## Order Book Method
- This is what all stock markets use
- Disadvantages:
  - A single centralized authority
  - Typically takes (relatively) high fees
  - You have to either wait until somebody agrees to your exchange terms
    - Or set a low price to sell immediately
  - Your funds are "locked" up until either the exchange happens or you cancel the order
- Very few decentralized exchanges use this

## Liquidity Pool
[![](https://finematics.com/wp-content/uploads/2020/07/lp-pools-768x361.png)](https://finematics.com/liquidity-pools-explained/)
- A liquidity pool starts off with a specific ratio of tokens
  - 50%:50%, for example
  - The ratio is the *dollar value*, not the number of tokens
- One can add to the pool by putting in an equal *value* of each token
  - One earns fees on your contribution; more later
- But how to determine the price?
  - Most pools use the Constant Product Automated Market Maker method
  - We'll see the ~~Constant Product~~ Automated Market Maker method first

<h2 class="r-fit-text">Automated Market Maker Method (AMM)</h2>

- Basic idea: as you buy, from a pool, currency A by selling currency B...
  - The price of currency A goes up (since there is less in the pool, it must be more in demand)
  - The price of currency B goes down (since there is more in the pool, it must be less in demand)
- To keep the 50:50 price ratio constant...
  - It has to raise the price of one and lower the price of the other

## AMM Example
- Assume we have fETH (fake ETH) at $1 per coin
- Assume we have TC (TokenCoin) at $0.1 per coin
- The pool has:
  - 100 fETH valued at `$`100
  - 1,000 TC valued at `$`100
  - Exchange rate: 1 fETH = 10 TC
  - Total pool value: `$`200
- 25 fETH are exchanged for 250 TC (both are worth $25)
  - Minus a (small) fee: perhaps 0.3%; we'll ignore this
- The pool now has 75 fETH and 1,250 TC
  - Exchange rate: 1 fETH = $16\frac{2}{3}$ TC
- ... but what is this worth in USD?

## Value in USD
- A decentralized exchange only determines the *exchange ratio* between the tokens in its liquidity pool
  - 1 fETH for 10 TC, for example
- This exchange rate may be quite different than that of other exchanges
  - We'll address this in a bit
- The *market value* is how much each is worth in USD
  - This is determined by external factors, not by the DEX
- But we can estimate it...

## Estimated value in USD
- The pool now has 75 fETH and 1,250 TC
- Assume the USD value of the entire pool remains the same
  - And each commodity is worth exactly half of that
  - We are ignoring market fluctuations for now
- `$`200 was put in: `$`100 as 100 fETH and `$`100 as 1,000 TC
- The pool is still worth `$`200, half to each commodity
  - The 75 fETH is worth `$`$100/75=$ `$`1.33 in USD
    - Instead of the initial `$`1 it was worth
  - The 1,250 TC is worth `$`$100/1,250=$ `$`0.08 in USD
    - Instead of the initial `$`0.10 it was worth
- This only holds if the *exchange rate* doesn't change

## AMM Example
- Imagine a pool with a much more liquidity
  - 100,000 fETH valued at $100,000
  - 1,000,000 TC valued at $100,000
  - Exchange rate: 1 fETH = 10 TC
  - Total pool value: `$`200,000
- 25 fETH are exchanged for 250 TC (both are worth $25)
  - Minus a (small) fee that we'll ignore
- The pool now has 99,975 fETH and 1,000,250 TC
  - Exchange rate: 1 fETH = 10.005 TC
  - The more liquidity in a pool, the less the price changes with each exchange

## Problem with AMM
- Given the initial pool of 100 fETH and 1,000 TC
  - Exchange rate: 1 fETH = 10 TC
- We start with (only) 100 fETH
- We buy 990 TC for 99 fETH, as per the exchange rate
  - We now have 1 fETH and 990 TC
  - The exchange has 199 fETH and 10 TC
- New exchange rate: 199 fETH and 10 TC: 1 fETH $\approx$ 0.05 TC
- We then buy our 99 fETH back for $99 \ast 0.05$ TC $= 4.95$ TC
- We now have:
  - Our original 100 fETH
  - 990 TC - 4.95 TC $\approx$ 985 TC
- So clearly this is not viable...

## Liquidity Provider
- A *Liquidity Provider* is some entity that puts money into a liquidity pool
- The fees generated go to the liquidity providers
  - Your percentage of the fees depends on the percentage of your liquidity in the pool
- Some pools are offering APR of 500%
  - Yes, *five hundred* percent per year
  - But that seems kinda scammy...
- As more people join the pool, your cut is less and less

## Adding liquidity to a pool
- Two competing invariants:
  - $x \ast y = k$
  - Ratios are $x/y$ and $y/x$
- Solution: keep the ratio the same, and adjust $k$
  - If adding $a$ of the first commodity, add $a \ast y/x$ of the second
  - This keeps the ratios (and the exchange rate) the same
- Then recompute $k$ based on the new $x$ and $y$ values

## Adding liquidity example
- Assume the pool has 100 fETH and 1,000 TC
  - Constant $k=100,000$
  - Exchange rate: 1 fETH = 10 TC
  - So for every 1 fETH we add, we have to add 10 TC
- We thus add 10 fETH and 100 TC
  - Pool now has 110 fETH and 1,100 TC
  - Exchange rate is still 1 fETH = 10 TC
- Compute new constant $k$
  - $k = 110 * 1,100 = 121,000$

## Joining a liquidity pool
- With a high rate of return, why doesn't everybody partake in a liquidity pool?
- Some typical reasons:
  - Need a lot of liquidity in multiple currencies
  - Many people don't know about it
- Three unique reasons:
  - Impermanent loss (aka Divergence Loss)
  - Rug pulls
  - Bugs

## Impermanent loss
- Basic idea: consider how much you would have made if you did not invest in a liquidity pool
- If that amount is less than the liquidity pool, then the difference is your *impermanent loss*
  - Impermanent because it is not permanent until you sell

## Impermanent loss
- This happens when one of the commodities changes price differently than the other
  - Reason: arbitrage traders take *value* out of a liquidity pool when equalizing exchange rates
  - Or the prices *diverge* -- this is also called *divergence loss*
- Analogy: "paper loss" when a stock price goes down
  - But if you wait, you can reverse that loss *if* the price goes up

## Impermanent loss example
- Consider ETH and a stablecoin such as USDT
  - Let the market rate be 1 ETH = `$`1,000
  - And 1 USDT is always `$`1
- We put into our liquidity pool:
  - 10 ETH = `$`10,000 (so $x=10$)
  - 10,000 USDT = `$`10,000 (so $y=10,000$)
  - Total pool value is `$`20,000
  - $k = x \ast y = 10 \ast 10,000 = 100,000$

<h2 class="r-fit-text">Impermanent loss example 1, part 1</h2>

- Our pool: 10 ETH and 10,000 USDT; $k=100,000$
- Imagine the price of ETH drops to `$`800
- An arbitrage trader buys 2 ETH for `$`800 each from Coinbase
- And exchanges it with our DEX for USDT
  - As per CPAMM, they get 1,667 (rounded) USDT
    - They paid `$`1,600 for those 2 ETH, so they made `$`67
  - Our DEX now has 12 ETH and 8,333 USDT, so $k$ is the same

<h2 class="r-fit-text">Impermanent loss example 1, part 2</h2>

- Current price of ETH is `$`800
- Our DEX has 12 ETH and 8,333 USDT
  - Current value: 12 $\ast$ `$`800 + `$`8,333 = `$`17,933
- What if we had not invested in the liquidity pool?
  - We would have our original 10 ETH plus 10,000 USDT
  - Value would have been: 10 $\ast$ `$`800 + `$`10,000 = `$`18,000
  - That's `$`67 more!
- Our impermanent loss was `$`67

<h2 class="r-fit-text">Impermanent loss example 2, part 1</h2>

- Our pool: 10 ETH and 10,000 USDT; $k=100,000$
- Imagine the price of ETH rises to `$`1,300
- An arbitrage trader exchanges USDT for 2 ETH from our DEX
  - As per CPAMM, they pay 2,500 USDT
  - Our DEX now has 8 ETH and 12,500 USDT, so $k$ is the same
- And sells the 2 ETH to Coinbase for `$`2,600
  - They made `$`100 profit

<h2 class="r-fit-text">Impermanent loss example 2, part 2</h2>

- Current price of ETH is `$`1,300
- Our DEX has 8 ETH and 12,500 USDT
  - Current value: 8 $\ast$ `$`1,300 + `$`12,500 = `$`22,900
- What if we had not invested in the liquidity pool?
  - We would have our original 10 ETH plus 10,000 USDT
  - Value would have been: 10 $\ast$ `$`1,300 + `$`10,000 = `$`23,000
  - That's `$`100 more!
- Our impermanent loss was `$`100

## Impermanent loss
- How much of a loss is this?
- The formula is:

$loss = \frac{2*\sqrt{price\\_ratio}}{1+price\\_ratio}-1$

- We are skipping the derivation of this, but you can see details of that derivation [here](https://dappgrid.com/what-is-impermanent-loss/)

## Impermanent loss
- Caused by arbitrage trading
  - The arbitrage traders are taking *value* out of the DEX
- Impermanent loss increases when the prices of the commodities diverge
  - With a stablecoin and a volatile coin
- More pronounced with two volatile coins that move in different directions
- It's not a problem when the two coins grow at the same rate

## Impermanent Loss Insurance
![](images/applications/bancor-insurance.webp)
- [Bancor](https://home.bancor.network/) offers insurance against impermanent loss
- ... unless they might lose money, then [they will pause it](https://web3isgoinggreat.com/?id=defi-insurer-bancor-pauses-their-impermanent-loss-protection-due-to-hostile-market-conditions)
  - Posting on the right from [Web3 is going just great](https://web3isgoinggreat.com/?id=defi-insurer-bancor-pauses-their-impermanent-loss-protection-due-to-hostile-market-conditions)
  - Bancor's [June 19, 2022 update about this](https://blog.bancor.network/market-conditions-update-june-19-2022-e5b857b39336)

## Rug Pulls
[![](https://bitcoinist.com/wp-content/uploads/2022/02/pull.jpg)](https://bitcoinist.com/rug-pull-dont-fooled-ways-detect-someones-scam-you/)
- When the DEX owner runs off with your coins
- Recall `selfdestruct(address)`
  - The parameter passed in gets all the ether that the contract controls
  - We can easily ensure only the deployer can call it, and have it transfer the TC in the process
- In 2021, an estimated 7.7 billion was stolen in rug pulls ([source](https://www.bitchecker.com/en-US/articles/67))

![](images/applications/aku-nft-lock.webp)
## Bugs
- This was an NFT auction, not a DEX, but...
- [AkuDreams NFT project earns $34 million that its team will never be able to withdraw](https://web3isgoinggreat.com/?id=akudreams-earns-34-million-team-will-never-be-able-to-withdraw)
  - Also: [Aku Ethereum NFT Launch Ends With $34M Locked in Flawed Smart Contract](https://decrypt.co/98530/aku-ethereum-nft-launch-ends-with-34m-locked-in-flawed-smart-contract)

## Benefits & Drawbacks
- Benefits
  - No KYC, since it's decentralized
  - Often open source, so anybody can check the code; thus, more trust
  - Much faster than centralized exchanges; much smaller fee
- Drawbacks
  - No customer support (*maybe* community forums)
  - Send to the wrong contract address?  Tough luck, your cryptocurrency is lost
  - Have to use a hot storage device -- a wallet connected to the Internet
  - May have low liquidity
  - Open source: one could find a vulnerability

## Examples
- Uniswap: smart contract exchange between Ethereum and various Ethereum token cryptocurrencies
- Bancor: an entire protocol that competes with Uniswap
- SushiSwap: operates on many blockchains
  - But cannot swap between different blockchains
- Balancer: allows up to 8 assets in a liquidity pool
  - Has *very* complicated algorithms to manage this
- See a list of various DEXs [here](https://defillama.com/)
  - And detailed [directions how to use Uniswap](https://beincrypto.com/learn/how-to-use-uniswap/)

## [Uniswap](https://uniswap.org/)
![](images/logos/uniswap-uni-logo.svg)
- Version 1 in 2018; v2 in 2020, and v3 in 2021
- V2 had `$`135 *billion* in value
- Information about Uniswap is [here](https://uniswap.org/blog/uniswap-v3)
- Features:
  - Slippage prevention
  - Different risk tiers with different fee rewards
- You can see the currency swap web interface [here](https://app.uniswap.org/#/swap?chain=mainnet)

## Sources
- Much of the DEX slides were generated after learning about it from [Whiteboard crypto videos](https://www.youtube.com/c/WhiteboardCrypto/videos)
  - [DEX intro](https://www.youtube.com/watch?v=2tTVJL4bpTU)
  - [Liquidity pools](https://www.youtube.com/watch?v=dVJzcFDo498)
  - [Automated Market Makers](https://www.youtube.com/watch?v=1PbZMudPP5E)
  - [impermanent loss](https://www.youtube.com/watch?v=_m6Mowq3Ptk)
  - [Rug pulls](https://www.youtube.com/watch?v=YFaqng3YESE)

## DAOs
- DAO = Decentralized Autonomous Organization
- An organization whose membership and rules are governed by a smart contract 
- Membership often managed by an ERC-721 (or ERC-1155) NFT
  - They can instead issue ERC-20 (or ERC-1155) tokens if some members have "more" voting rights than others
- They are still in their nascent stage

## DAO generic examples
- An organization that allows for voting by its members
  - Some/all members can propose polls to vote upon
  - The smart contract hosts the polls and only members can vote
- A charity distribution organization
  - Members donate to the contract, and the funds are disseminated to the charities that the members vote upon
- Governance of another cryptocurrency
  - Often used for stablecoins, which we'll see later
- Anything where there is management needed of funds and/or votes

## DAO Specific Examples
- [DASH](https://www.kraken.com/learn/what-is-dash), a cryptocurrency managed by its members
- [![mkr logo](../slides/images/logos/mkr-coin-symbol.svg)](https://coinmarketcap.com/currencies/maker/) [MakerDAO](https://www.kraken.com/learn/what-is-maker-mkr), a software that manages the [![dai logo](../slides/images/logos/dai-coin-symbol.svg)](https://coinmarketcap.com/currencies/multi-collateral-dai/) DAI stablecoin
- [Augur](https://www.kraken.com/learn/what-is-augur-rep), a prediction market platform
- [MolochDAO](https://molochdao.com/), which focuses on funding Ethereum projects

See [here](https://deepdao.io/organizations) for a list of some well-known DAOs

## The DAO (styled Ð)

- A venture capital investment DAO launched in April 2016; now defunct
  - Code is open-source (GPL): [DAO.sol](https://github.com/blockchainsllc/DAO/blob/develop/DAO.sol)
    - That code contains both an interface and a contract in one file
  - Raised `$`150 million from over 11,000 investors in a month
    - That was 15% of the value of all the minted ether at that point
- A hack in June 2016 drained all the ether from the DAO
  - Because of how much ETH was in The DAO, it had a serious effect on the entire Ethereum system

## Background: Receiving ether
- For a smart contract to receive Ether, it has to have a function enabling it to do so
  - This is for generic receipt of ether, which is separate from a `payable` function
- In earlier versions of Solidity:
```
function () { ... }
```
- In current versions of Solidity (0.8.x):
```
receive() external payable { }
```
- The function doesn't have to *do* anything, but it does need to exist
  - Otherwise a transfer of ether to the contract will revert

## Recursive send: how to fix
- Lots of ways to fix this:
  - Zero the balance *before* the transfer, and save into a separate local variable
  - Check the return value of the transfer (not guaranteed to fix it, though)
  - Verify that the ether balance after is what was expected
  - And so on...
- This was specifically addressed in the Ethereum programming guidelines at the time
  - But was ignored by many programmers
  - Including those of The DAO

## Background: The DAO splits
- The DAO allowed "splits" to create "child" DAOs
  - Presumably to focus on some specific aspect of venture capital investments
  - Or to manage one specific investment
- Funds would be transferred to the child DAO
  - That transfer was susceptible to a recursive send attack

## Mitigation
- As this attack was happening, The DAO members tried to split The DAO to prevent this
  - But were unable to get the votes in time
- This is a known problem with DAOs: people don't always vote in a timely manner
  - Or don't vote at all, or lose their account, etc.

## Mitigation
- Vitalik Buterin (Ethereum's creator) suggested blacklisting the attacker
  - A so-called "soft fork"
  - The attacker pointed out (anonymously) that his/her actions did not violate any laws
- The attacker, on the DAO's Slack channel, then bribed miners with 1 million ETH and 100 BTC to not comply with the mitigation
- This entire episode (and the bribe) split the community into two about how to respond
  - And raised lots of philosophical questions

## Mitigation
- The final result:
  - There was a *hard* roll-back (or hard fork) of the blockchain to before this attack
    - Invalidating all transactions since then
  - There were a number of bug fixes and mitigation strategies
  - The DAO got its funds back, and later disbanded
- But not everybody agreed with this approach!

## Hard fork details
![](images/applications/ethetc/ethetc.dot.1.svg)
- You can see the exploit wallet destination on both [ETH](https://etherscan.io/address/0x304a554a310c7e546dfe434669c62820b7d83490) and [ETC](https://etcblockexplorer.com/address/0x304a554a310C7e546dfe434669C62820b7D83490)
- The last common block was [ETH block 1,919,999](https://etherscan.io/block/1919999) and [ETC block 1,919,999](https://etcblockexplorer.com/block/0xa218e2c611f21232d857e3c8cecdcdf1f65f25a4477f98f6f47e4063807f2308)
- The next block:
  - [![eth logo](../slides/images/logos/eth-coin-symbol.svg)](https://coinmarketcap.com/currencies/ethereum/) [ETH block 1,920,000](https://etherscan.io/block/1920000) was the "hard fork"
  - [![etc logo](../slides/images/logos/etc-coin-symbol.svg)](https://coinmarketcap.com/currencies/ethereum-classic/) [ETC block 1,920,000](https://etcblockexplorer.com/block/0x94365e3a8c0b35089c1d1195081fe7489b528a84b22199c916180db8b28ade7f) had the old (faulty) DAO code
- A very thorough account is [here](https://www.coindesk.com/learn/understanding-the-dao-attack/)

## DAO as currency governance
- Create a currency or blockchain
  - And a separate DAO to manage it
    - Issue token(s) (either ERC-20 or ERC-721) to allow people to vote
- Example we'll see in [Stablecoins](stablecoins.html#/colldecen):
  - [![dai logo](../slides/images/logos/dai-coin-symbol.svg)](https://coinmarketcap.com/currencies/multi-collateral-dai/) Dai ([DAI](https://coinmarketcap.com/currencies/multi-collateral-dai/)) is the stablecoin <br clear='all'>
  - [![mkr logo](../slides/images/logos/mkr-coin-symbol.svg)](https://coinmarketcap.com/currencies/maker/) Maker ([MKR](https://coinmarketcap.com/currencies/maker/)) is the governance token <br clear='all'>

## DAO Governance Attack
- Buy enough of a governance token for a DAO (or other DeFi system)
  - Especially when it's cheap or when its price has crashed
  - Then manipulate the associated currency / platform
- Example: [April 2022 attack against Beanstalk Farms](https://www.theverge.com/2022/4/18/23030754/beanstalk-cryptocurrency-hack-182-million-dao-voting)
  - Attacker took a `$`1 billion "flash loan" of cryptocurrency
  - Then bought 67% voting stake
  - Voted on a change to the system (the DAO allows this)
  - Transferred assets to his/her own wallet
  - Net gain: about `$`80 million
  - Elapsed time of attack: 13 seconds (sic)

## Definitions

> Whale: one who owns a large amount of a given cryptocurrency, and whose trades can significantly affect the price

> Airdrop: a free distribution of a small amount of a cryptocurrency to (usually many) users, meant as a reward or to generate hype

## DAO and governance issues
- Consider the [JUNO vote from March 2022](https://web3isgoinggreat.com/?id=juno-community-votes-to-take-community-members-tokens)
- A whale manipulated an airdrop to gain a huge amount of [![juno logo](../slides/images/logos/juno-coin-symbol.svg)](https://coinmarketcap.com/currencies/juno/) Juno tokens
  - Over 3 million tokens, worth `$`117 million at the time
  - This many tokens could be used to manipulate the price by, say, wiping out the liquidity of the DEX
    - Or to bribe validators (miners)
  - It was creating fear in the community, and destabilizing JUNO
- Proposal: to take away the whale's `$`123 million in JUNO
- No simple simple answer, but the vote (barely) succeeded
  - Many felt that it [set a dangerous precedent](https://twitter.com/ertemann/status/1502255256536821761?s=20&t=sJPPz4-cppsWjjdD1fnwhA)
- A DAO can remove your cryptocurrency holdings!
  - Whether they were gained legitimately or through a attack

## References
- [ethereum.org page on DAOs](https://ethereum.org/en/dao/)
- [Some well known examples of DAOs](https://geekflare.com/finance/dao-crypto-projects/)
- [Vitalik Buterin's blog post about the DAO vulnerability](https://blog.ethereum.org/2016/06/17/critical-update-re-dao-vulnerability/)
- [Another description of the attack](https://hackingdistributed.com/2016/06/18/analysis-of-the-dao-exploit/)