Please describe your proposed solution.
In general, current DeFi applications are limited by financial inefficiencies that need to be addressed in order to be able to compete with centralized finance. While the orderbook approach is inherent to Cardano's unique eUTXO model, this is not the case for the automated market maker (AMM) model pioneered by Uniswap and currently implemented by most Cardano DEXs.
The Uniswap V2 style AMM model currently used in most Cardano DEXs has multiple major downsides. For one, the liquidity provided by users is not used efficiently and liquidity providers are facing impermanent loss which often outweighs the gains. This in turn makes liquidity provision without further incentives unattractive and only accessible to expert investors. At the same time, most of the currently deployed dApps rely on centralized components to solve technical challenges related to porting the AMM model from account-based blockchains - such as enforcing a correct time order between open swaps.
We will research and propose novel liquidity provision models in order to address problems like inefficient use of liquidity and impermanent loss. We will turn this research into open source smart contracts that will be made available to the entire Cardano community. Solving this problem will involve consultation with experts from traditional finance, development of Plutus smart contracts and smart contract audits to ensure safe community contracts.
Even though other projects are exploring similar avenues, we believe the area of efficient use of liquidity in DeFi deserves attention and it is beneficial to have multiple research projects ongoing in parallel together with risk mitigation. Ultimately, the blockchain offering the best suite of financial instruments and tools to DeFi users will grow in terms of market share. We are trying to exploit the unique model of Cardano to achieve this goal.
Please describe how your proposed solution will address the Challenge that you have submitted it in.
To improve the competitiveness of the Cardano dApp ecosystem, we need to build native dApps that take advantage of the Cardano EUTXO model instead of copying popular models seen in account-based blockchains like Ethereum. The EUTXO model allows for different and more scalable solutions. For instance, the MuesliSwap dApp uses an order book approach that is uniquely suited to the Cardano EUTXO model. The same should be done for models like automated market makers that aim to provide additional liquidity to Decentralized Finance. With this project, we are aiming to develop open-source, high-quality code that can be used as a basis for the next generation of Cardano dApps. Building a protocol that protects users from impermanent loss and using liquidity provided more efficiently will help to attract more DeFi users to Cardano and mitigate the risks for new users. Finally, by open sourcing our code and audit process, we will be able to share best practices of Cardano development with future Plutus developers.
What are the main risks that could prevent you from delivering the project successfully and please explain how you will mitigate each risk?
As we already have an overview about areas that can be improved along with initial ideas how these improvements can be implemented, we don’t see any risk that the project can’t be delivered successfully. Also, we will not encounter any budget problems as any extra costs will be covered by the MuesliSwap team. As we have a big development team, we will also not encounter risks like lack of development staff. As a research oriented proposal, it might be that our findings are not optimal. We see this proposal in the context of many projects researching in the area in order to maximize the overall progress of Cardano DeFi.