Bullish calls it
This week, developers Block.one and a list of big-name investors announced the formation of the apparently unironically named Bullish Global, a new crypto asset exchange intended to launch this year. The news follows April's Coinbase IPO.
Bullish's announcement indicates that the company wants to combine the benefits of market-making based on order books with newer blockchain-based automated market-making algorithms.
There is a deep irony to the idea that Bullish Global could be considered to be pursuing something called "decentralized" finance, in light of its multi-billion-dollar capitalization and backing from what are unquestionably central financial players, including, for example, Nomura. But let's see what this is about.
Automated market-making
What is automated market-making? A recent development among crypto-futurists, on which Bullish builds, has been around so-called decentralized finance, "DeFi" to the impatient. Popularized by Uniswap, PancakeSwap, and Curve, automated market-makers allow holders of different assets on a single blockchain to capitalize a fully automated two-way market-making operation. Other users can access the mechanism to trade blockchain-based asset pairs.
There are variations in implementation, but in outline it works like this. The owner of two types of asset on a blockchain (typically Ethereum) deposits quantities of both assets (e.g., Ether and USD Tethers) into the AMM pool, in return for which they receive a token entitling them to a share of the pool's assets. Once capitalized, users who wish to exchange ETH for USDT, or USDT for ETH, can transact with the pool through a web interface. Each transaction changes the balance of the two assets in the pool. Each transaction also incurs a fee, which accrues to the pool. Later, tokens can be withdrawn from the pool, payable as a share of the two traded assets, which may have changed since the funds were deposited. The transactions could be represented like this (without quantities):
The automated market-maker relies on an algorithm to update the price at which trading is offered to liquidity takers, and which also determines the ratio at which funds can be deposited to the pool. There are variations, but an important example is a constant-product rule: if x and y are the quantities of the two assets in the pool, a valid transaction must leave the product xy unchanged. This has the effect of making transactions that are large relative to the size of the pool very expensive for the liquidity taker. It also automatically creates the possibility for arbitrage if the pool price is moved far from prices for the same pair on other markets.
Bullish's capitalization
Bullish is a project of the developers of the EOS blockchain, and the announcement suggests it intends to use its capital to fund automated market-making. But then the AMM design raises some questions.
The vast majority of Bullish’s capital comes in the form of 164,000 bitcoins, valued at $8 billion as I write. But bitcoin exists on its own blockchain, not on EOS. So if Bullish intends to use its capital to fund automated market-making on the EOS blockchain, it will require a narrow bank or stablecoin issuer to bring that BTC, and the much smaller USD capitalization, on chain.
To fix ideas, we could write this out in T accounts. Think of Bullish as a liquidity pool like the one above. The owners of its capital want to put their 100m USD and 164k BTC into the pool. But BTC and USD are not on the EOS chain. So there will have to be an EOS narrow bank (i.e. a 100% reserve bank) that holds USD and BTC and issues wrapped or tethered assets on the EOS chain.
Who will own this narrow bank? It could be on Bullish's books, in which case holding wrapped assets amounts to holding a deposit account with Bullish, which is far from the DeFi ethos. Or it could be somewhere else, in which case the whole thing rests on a yet-to-be-named third-party issuer or ecosystem of small issuers. Whether it happens on Bullish's books or externally, the liquidity mismatch between EOS's own blockchain, which is intended to be fast, and the bitcoin native blockchain, which is quite slow, will be significant. A quick widespread exit from BTC could make it very hard to maintain one-to-one backing.
Can Bullish capitalize a market-making operation with only BTC? 164,000 bitcoins seems like a large amount to simply sell. But this week’s tweet-induced 10% price drop does argue for caution: if at any point there is a widespread move from bitcoin to dollars, Bullish's already lopsided inventory will quickly be empty of dollars altogether. Selling the BTC won't be of much help, because the dollar price of bitcoin would already be falling quickly.
The profitability of market-making depends rather fundamentally on order flow. For there to be flow, there must be both buyers and sellers. Bullish's capitalization makes it look, rather, like they are sellers of bitcoin looking for buyers.
I conclude
The simplest explanation, to my thinking, is that all of this is an elaborate way to exit a large position in bitcoin, timed to come at the top of the market. I don't know how else to square the unbalanced capitalization with the doublespeak-ish nod to "decentralization" and the unlikely resurrection of the EOS blockchain.
Maybe I'm wrong, and Bullish is poised to disrupt centuries of price-making with a concept that is able to trace its origins all the way back to 2017. Either way, I look forward to seeing how it fares during a systemic liquidity crisis!
Message to readers
Thanks for reading Soon Parted! I wanted to thank those of you who have reached out, via email or Twitter, with questions or thoughts in response to my posts. I can’t quite keep up with them individually. But I do respond to them all, eventually, in Soon Parted itself.