Five Small Cap Projects on Arbitrum

STFX stands for Single Trade Finance Exchange, and it functions like a hedge fund for individual trade ideas. While the vast majority of retail traders are unprofitable, STFX gives retail the opportunity to invest in trades placed by experienced traders. Here’s how it works:

An established trader with a verifiable on-chain track record lays out an idea on STFX, and other users can invest their own funds though a vault to take part in the trade. The vault manager handles all the execution and receives a 15% performance fee on profitable trades, but nothing on losing trades. 5% of net profits also go to the protocol treasury, of which 80% is distributed to staker of the STFX native token, with the other 20% going to the treasury DAO. These staking rewards are paid out weekly in USDC, adding a solid real yield component to the protocol.

The platform is also built on top of GMX, giving traders direct access to the deep liquidity and leverage available there, and in turn providing more trading volume and fee generation for GMX in a nice symbiotic relationship.

While the platform isn’t fully live yet, the recent Alpha trading competition gave some insight into the early adoption numbers.

Since the max investment for each trade idea was capped at $200, seeing over $150k invested is quite impressive, as is 3,000 users during a 1 month alpha. Given these early numbers, the relative abundance of traders on Arbitrum, and the opportunity to stake and earn real yield, there seems to be a clear product-market fit for STFX. STFX has also just concluded their public sale, which raised $6M in only four days.

Next up let’s take a look at Contango, which offers expirable instruments. Think perpetual futures, like those offered by GMX or DyDx, but with a set date and price. This product is a staple in the world of TradFi, but has not yet been replicated in a truly decentralized fashion until now.

Contango creates a synthetic expirable instrument for traders by:

1. Borrowing the quote asset via Yield Protocol’s fixed rate market
2. Trading that borrowed asset for the base asset via Uniswap spot market, then
3. Taking that base asset back to Yield to lend out. All of these transactions are done in a single block in order to take advantage of the flash swap feature on Uniswap for improved capital efficiency.

Yes, it's a bit complex under the hood, but the protocol does all those steps for the user, giving them the expirable price without the work of setting it up themselves. See the graphic below for a visual explanation of this process, with ETH as the base asset and DAI as the quote asset. This page of the documentation also provides a real on-chain example including each transaction that is executed in the creation of a Contango expirable contract.

This same process is also used for shorts by inverting the position of base and quote assets, and this method also allows for the use of leverage by increasing the amount borrowed. With this system Contango is able to offer expirable instruments without needing to maintain an order book or liquidity pools.

Use cases for expirables are quite similar to those of the perpetuals that Arbitrum traders are already familiar with, namely speculation with or without leverage, and hedging. There’s also the possibility of using Contago to obtain leverage on a “cash and carry” arbitrage trade, a strategy slightly too complex to cover in this piece, but certainly one that will be familiar to derivatives traders. Bottom line, expirables are a product that has seen success in both TradFi and in crypto, but so far only through centralized platforms like BitMEX. Contango has figured out how to offer them in a fully decentralized fashion, and this is a type of product that experienced derivatives traders will be excited to see.

The beta recently went live on December 15th, but as the team has noted audits are not yet complete so use at your own discretion for now. Overall this seems like a platform more geared towards experienced traders vs the general retail population, but the objective of this piece is to highlight unique DeFi offerings, and Contango fits the bill.

Continuing with the derivatives theme, let’s look at GammaSwap, a protocol which will allow traders to go long gamma (the volatility of an option’s price given a 1 point change in the underlying asset’s price). In order to create a long gamma investable product, GammaSwap acts as an intermediary for LPs to deposit in the pools of constant product AMMs including Uniswap, Balancer, and SushiSwap.

The premise here, which is fully outlined in this article by GammaSwap co-founder Danr, is that AMM liquidity pools work like a sort of options market from the LP perspective, and LP positions in these pools are essentially taking on a short straddle position in exchange for the fees and rewards for depositing their capital. This is one of the main reasons why the majority of LPs don’t see long term profitability.

Now, if participants could buy volatility instead of only being forced to sell it, then LPing becomes much more attractive, which is a plus for LPs, AMMs, and users, and this is where GammaSwap comes in. I’ll include this graphic from the Litepaper here to help visualize the concept.

GammaSwap aims to provide access to the long side of this gamma exposure by lending out LP tokens obtained through facilitating AMM pool deposits, creating a marketplace for implied volatility. Since LP tokens are being loaned out, In order to access long gamma positions users will have to deposit the underlying assets of a given pair as collateral,WETH/USDC for example. Long gamma positions will also pay the short gamma positions (LP token lenders) interest for borrowing their LP tokens. This next graphic shows how the different tokens involved flow through GammaSwap using the WETH/USDC example and uniswap as the AMM.

The protocol recently launched its testnet version on December 19th, and reportedly had over 1500 users in the first couple days. The large amount of LPs across the major constant product AMMs like Uni and Sushi gives GammaSwap a solid potential user base to work with, and being the first mover in this implied volatility marketplace offers additional upside. The two primary use cases for GammaSwap will be for LPs to hedge their gamma exposure while continuing to earn swap fees, and on the flip side for LPs to sell that hedge to earn interest payments. Additionally, traders could use GammaSwap positions like synthetic leveraged options, with the added benefit of no liquidation risk in exchange for some extra slippage.

Vendor is a lending protocol with a very different approach, allowing individual wallets or treasuries to lend out assets and dictate their own terms for doing so. It’s permissionless and fully customizable, but all loans are fixed in both term and rate from origination. One of the most interesting aspects of the Vendor loan system is that there are no liquidations; borrowers either pay back the loan & interest at the end of the term, or default and keep the loaned token while the lender gets the collateral. This caveat, combined with the customization factor, creates some unique use cases for both lenders and borrowers.

Lender uses:

• Earning yield on idle assets- Protocol/DAO treasuries could lend out native tokens to earned fixed income, with the ability to set rates as they see fit.
• Perpetual loans- while loans on Vendor are fixed in term, lenders can set up a rollover feature where the loan will renew at the end of the term, essentially creating a perpetual loan with a fixed stream of income.
• Potential to pick up some cheap tokens- This would involve loaning out stablecoins or bluechip tokens for an altcoin the lender would like to acquire as collateral. The lender would establish a favorable LTV, and if the loan is defaulted on they would collect the collateral token at a discount.

Borrower uses:

• Yield farming- borrow a token capable of earning a higher APR than the interest rate, while still retaining exposure to the collateral asset
• Hedging- it is possible that the loan taken out could become more valuable than the collateral posted, in which case the borrower enters a scenario where defaulting becomes profitable, thus acting as a hedge on the collateral asset.
• Borrow without liquidation risk

As of now, Vendor is live on Arbitrum, but still in Beta, and no token has been announced so far. However, with platform fees consisting of 3% of defaulted collateral and 10% of earned interest, there is potential for a share of this revenue to be accrued to token holders if one is launched in the future. Since it’s only in beta the list of tokens available for lending and borrowing will certainly expand, but the 17 currently offered cover most of the major stablecoins, plus ETH, BTC, and several from fellow Arbitrum protocols ($Y2K which I’ll cover next was recently added). Umami is by far the most popular asset in use, and TVL has grown to $1.6 million since the beta started in late October.

Overall, the uniqueness and flexibility of Vendor sets it apart from traditional lending platforms, addressing the currently underserved p2p lending market. Its experimental nature fits well with the willingness of Arbitrum users to try out new DeFi concepts, and the fee structure generates legitimate revenues which could be used to play into the real yield narrative if a token is created along with or after the full launch.

Note: Frogs Anonymous and Y2K are both affiliated with New Order DAO. While I genuinely believe the products offered by Y2K are valuable additions to both Arbitrum and DeFi in general, this seems like info worth disclosing.

Speaking of experimental and unique DeFi products, Y2K is another one to keep an eye on with its product for stablecoin depeg insurance. Stables are a $140 billion sector, making up a solid chunk of crypto’s total liquidity, but before Y2K there was no way to hedge or bet on volatility in the stablecoin market. Y2k offers vaults for USDT, USDC, DAI, FRAX, WBTC, and MIM, and for each asset, users have the choice of either buying or selling insurance on that particular peg.

Insurance buyers are paid out if the peg drops below their chosen threshold within a designated time period, and sellers are paid out if the peg holds above for the duration of the period. Deposits and payouts are both done in ETH, and there are weekly and monthly options for duration.

This is a useful tool for stablecoin holders concerned about a depeg, as well as ETH holders who are confident in peg stability and are looking for a yield opportunity. In the short time since Y2K launched on October 31st, both MIM and USDT have reached their respective depeg thresholds, triggering payouts to insurance buyers, and given the unlikelihood of these events the compensation can be juicy. Check out this example from the MIM depeg.

The timing for Y2K’s launch couldn’t have been better, as the protocol was able to prove its hedging use case with those two depegs and undergo a significant stress test right from the jump. For an insurance protocol, a live demonstration of why it’s worth using is quite convincing, and certainly has factored into these usage numbers through the first 3 epochs. Approximately 24,000 ETH, or ~$29 million, has already flowed through Y2K during its first month of operation, with steady growth each epoch. Given the sheer size of the stablecoin market, this is nowhere near the ceiling for its insurance market, and Y2K is the only game in town.

The last important point I’ll mention has to do with tokenomics, as the native $Y2K token is used for governance and revenue sharing by locking $Y2K for $vlY2K. The distribution as a whole is relatively even, with the treasury and liquidity incentives combining for 65% of the total supply, and the other third being split between the team, investors, and early users. Revenue sharing is not quite as generous as GMX, but a solid 50% of revenues will go to $vlY2K holders. Revenues consist of a 5% fee on all hedge vault deposits, and a 5% on risk vault deposits only if a depeg is triggered for the specific vault. Obtaining $vlY2K requires $Y2K holders to deposit the tokens into the Balancer Y2K/wETH pool at a ratio of 80/20. To give a rough hypothetical of what the rev share could look like based on previous epoch volume:

10,000 ETH deposited in Epoch X, 50/50 split between risk and hedge vaults, 0 depeg events triggered, $vlY2K holders would earn 150 ETH in total for Epoch X - not bad at all for a weekly basis.

There you have it, five protocols that are poised to make a name for themselves in the burgeoning Arbitrum L2 ecosystem. All of them are either in the testing phase or launched fairly recently, so if you’re reading this, congratulations on being early. Keep in mind that this piece is written from a DeFi utility perspective, meaning that the chosen protocols are those that provide innovative use cases and have the potential for increased adoption. While these factors often translate well into protocol success, additional research should be done before making an investment decision. Basically NFA, DYOR, and ape smartly my friends.