NFT Liquidity Part Two: The Sudoswap AMM

Now that we've looked at the protocols covered in part one, enter SudoAMM, an upcoming automated market maker for NFTs that will respond to buy and sell pressure in a variety of customized ways. SudoAMM is an expansion on the NFT trading vertical, offering users instant liquidity on their floor NFTs while also allowing holders to LP their assets, a product offering that has yet to be seen in the rapidly growing NFT space. While the dominant NFT marketplaces operate as centralized exchanges, SudoAMM aims to unlock a previously untapped niche within the NFT space and offer deep liquidity for JPEGs with a Uniswap V3 style mechanism.

To boil it down, the crux of how this protocol works under the hood is that orders to buy or sell NFTs will be routed through the best pools to find a quote depending on what side of the market a user is transacting (think aggregator). As it is permissionless and decentralized, anyone can create an on-chain liquidity pool for their NFT collection. Once created, traders can then interact with them to get instant liquidity quotes on orders and trade NFTs for ETH.

These pools are easily customizable, allowing users to create buy-only pools, sell-only pools, or both. Price quotes are determined by an underlying bonding curve that users will select upon pool creation (Chart 7), and three basic options will be available upon initial release.

First, a constant bonding curve always quotes the same price, regardless of volume. Linear curves display quotes that increase/decrease with buys/sells. Finally, exponential curves provide increasing/decreasing quotes as a function of x% with buys/sells (i.e., the more buys take place in a given pool, the quicker prices rise as a result).

A buy-only pool contains ETH and is always ready to give a quote to buy. A sell-only pool contains NFTs and is always ready to give a quote to sell. If both buying and selling are enabled, then the pool will give quotes for both. Users that trade with a pool will exchange either ETH for a whole number of NFTs or a whole number of NFTs for ETH (Chart 8).

Interestingly, as each pool can be mutually exclusive from one another, you can essentially have multiple underlying pools with varying parameters offering liquidity for a single NFT collection. When aggregated, these pools essentially function as an AMM, offering concentrated liquidity along various price points. This allows users to get immediate quotes on either the buy or the sell side for their NFTs. Particularly on the sell side, this will ideally give better slippage than existing methods (e.g. relying on an x times y=k + fractionalized token AMM or simply accepting the best offer on OpenSea).

In future iterations, sophisticated investors will have the ability to offer much more customizable pricing solutions. Rather than having liquidity providers deposit into the same AMM pool, users can create individual ETH/NFT pairs. By handling ETH and NFTs natively, SudoAMM can provide a gas-optimized swapping and liquidity provisioning experience.

Up until this point, the closest thing to resemble such a concept has been the introduction of fractionalization (breaking apart a JPEG into many parts). NFTX is one notable protocol that has tapped into this niche. The birth of fractionalization allowed retail to own pieces of prized possessions that normally would have been too expensive for the common user. While a big innovation on its own, fractionalization falls short in the quest for instant liquidity as it requires the sum of its parts to be sold across many participants, fragmenting liquidity. Many users instead wish to buy and sell whole quantities of NFTs.

Furthermore, NFTX operates under a constant product invariant model (x times y=k), whereby liquidity is provided across every price point. Frequent users of popular platforms such as Uniswap will realize that this means an equally balanced 50/50 pool of ETH and a subsequent NFT collection results in exponentially rising prices as one side of the pool is drained, up until a point where the price reaches infinity. This is quite cumbersome and capital intensive for NFT traders as it becomes much more difficult to calculate out the average purchase price of an NFT due to how these pools function.

When it comes to the sale of whole NFTs, Sudoswap’s competitors are all ultimately centralized, as detailed in part one of this article. As we all know, the cost of doing business on these exchanges is quite taxing, with users incurring both marketplace and royalty fees. This can essentially be seen as slippage. SudoAMM is able to offer tighter slippage as automatic market makers set custom spreads between buy/sell orders to profit off the trading volume in their pools, with net fees being orders of magnitude smaller than OpenSea (2.5% marketplace fees with royalties ranging from 0-10%).

This is also an untapped vertical for market makers as no other platform has yet to offer the ability for users to generate yield from providing liquidity for NFTs, as volume has been historically routed through the major platforms (e.g., OpenSea). SudoAMM allows for doing so in an on-chain way, with pricing that behaves predictably. The simplest example is someone locking up X ETH to buy NFTs at Y price or vice versa (assuming a constant bonding curve). Limit orders much? This is a powerful mechanism as it allows whales to potentially DCA in/out of a position with predictable pricing (Chart 9).

While SudoAMM has the potential to usher in a new wave of liquidity for NFTs, it still faces a few headwinds. One major implication of instant liquidity is that it is primarily focused on floor NFTs, assuming homogenous traits across each JPEG in the collection. As all of us astute JPEG collectooors will note, rarity is a huge price differentiator between floor and rare pieces, with the latter often commanding huge premiums due to its exclusivity. A potential workaround to this problem can be the creation of custom pools around certain traits, but the model itself falls short for exclusive traits in a collection of custom 1/1 pieces. A simple OTC swap or listing on OpenSea might be a more prudent approach in these circumstances.

SudoAMM is an innovative product offering unlocking liquidity for an asset class that continues to grow in both user count and volume – and liquidity is the backbone of any successful market. NFTs as an asset class have been historically viewed as a high-risk beta play on the underlying native token, with best cases scenarios offering returns in excess of 100x, while failed and botched launches see investor capital quickly dwindle to 0 as selling the asset becomes impossible.

This is because NFTs are notoriously illiquid. SudoAMM has the potential to capture a meaningful percentage of market share when it launches, as it will unlock deep and instant liquidity for various collections with tighter slippage, something no other protocol has been able to do yet.

While purely speculation, we have seen M&A activity in the space pickup of late, most notably with the acquisition of Gem.xyz by OpenSea. This acquisition was primarily driven by OpenSea’s desire to offer a better user experience for its users, with Gem.xyz offering an NFT marketplace aggregator product that OpenSea did not have. Could Sudoswap’s deep and instant liquidity platform be another potential candidate for the behemoth that is OpenSea? Who knows. What I do know is that its product offering is a logical next step for the space as it continuously expands and introduces new entrants. Any way you look at it, Sudoswap’s product offering is one that is desperately needed in the space and one I believe will be welcomed by many.