Key Point #3
Last updated
Last updated
Key Point 3: Seed both the FXPool and the external pool at a 50:50 LP ratio
Once the FXPool gets traded by the market away from the beta region (24:76 or 76:24 at current parameters), arbitrageurs must then be able to trade the FXPool and external pool against each other. This will result in the FXPool being traded back into the beta region, which then allows the market to trade at FX rate once more - until the FXPool LP ratio then again exits the beta region where arbitrageurs will then again rebalance the FXPool.
Below are some example of this mechanic working (see the blue and yellow lines representing the 2 tokens' weights in the pool):
This "rebalancing behavior" is not instantaneous, nor "automatic". The idea is simply that over time a trader (or "MEV bot") will pick up a profitable trade between the FXPool and an external pool ("buy low in one pool and sell high in another")
EURS:USDC Ethereum Mainnet
XSGD:USDC Polygon POS
VCHF:USDC Avalanche
This analysis was conducted on May 29, 2024. The state of the market and the example FXPools below may have changed by the time of reading
In the context of trading, arbitrage involves exploiting price differences between different token pools to achieve a profit. When the pools reach halt regions, there may be no profitable opportunities available, resulting in minimal trading activity. While FXPools by nature provide an incentive mechanism for arbitrageurs to rebalance the pools, the demand of external forces still serves as a factor to encourage the direction of trades. If your FXPool is not "rebalancing" throughout a certain period of time, you may notice that this is the case with other FXPools - the rebalancing behavior is not "instantaneous" (as seen in the Dune charts above). Absent any organic demand for trading the stablecoins in the FXPool, the only variable to trading volume and corresponding LP ratio over time will be the volatile token that is paired against the non USD stablecoin in the external pool. Depending on the price of that volatile token (whether ETH or some native gas token of the network), the pool may remain imbalanced until such a time when the price of the volatile token results in an arbitrage opportunity that brings the FXPool LP ratio back to the beta region.
However, it is possible to trace the price needed for trading activity to occur. Let us examine below where we analyze arbitrage opportunities across TXAU:USDC, TXAG:USDC and TXAU:TXAG:WETH as an example. In the below scenario, the ETH price is simulated in the screenshots.
| Pool | Project | Link |
|---|---|---|
TXAU:USDC | Balancer | |
TXAG:USDC | Balancer | |
TXAU:TXAG:WETH | Balancer |
Upon reaching halt regions in FX Pools, no profitable arbitrage opportunities are present, as both examined scenarios (ETH -> TXAU -> USDC -> ETH and ETH -> TXAG -> USDC -> ETH) result in minimal trading activity.
For context, the following are the asset prices for the various trading routes among the three pools mentioned above.
Arbitrage Scenario 1: ETH -> TXAU -> USDC -> ETH
In this arbitrage scenario, we start by converting ETH to TXAU, then TXAU to USDC, and finally USDC back to ETH. The key assumption here is that the price ratios between TXAU, and USDC remain constant during the transactions. The cycle aims to determine if the final amount of ETH obtained is greater than the initial amount, ensuring a profit.
First, 1 ETH is converted to TXAU at a given rate. The obtained TXAU is then converted to USDC using a constant exchange rate. Finally, the resulting USDC is converted back to ETH at the prevailing market rate.
For the trade in this scenario to be profitable, the final amount of ETH should exceed the initial 1 ETH. By solving the relevant inequality, it is determined that the price of ETH in USDC must be less than 3436.17 USDC. This threshold indicates the price point at which the arbitrage cycle becomes viable, leveraging the existing price differences between the token pools. Below is a deep dive on the computations:
For a detailed breakdown of the analysis, please refer to this document: https://docs.google.com/spreadsheets/d/1Tzm5uIXqsw0kspxgZrKLf5HMn67IlCZ007fkQdUhuT8/edit?usp=sharing
A potential solution to address stagnant trading activity is to increase the external pool size by supplying more liquidity. By enhancing the external liquidity in the pools (or adding more volatile token pairings), market participants are more likely to trade between the FXPool and external pool(s) due to expanded routes. This increased activity can, in turn, stimulate further trading as arbitrage opportunities become more apparent and accessible. Additionally, greater liquidity can attract more traders to the platform, fostering a more dynamic and active trading environment.
