“Gentlemen, there’s only two ways I know of to make money: bundling and unbundling.”
Jim Barksdale, formerly of Andreeson Horowitz
Aggregating over 188 sources of liquidity across 7 supported blockchains, with volumes greater than 134 billion USD, and over 1.6 million users, few DeFi projects epitomize Barksdale’s famous proclamation as much as the 1inch Network. In December 2021, 1inch successfully raised 175 million USD in a Series B, valuing the network at around $2.25 billion, led by Amber Group. The raise is aimed at navigating the regulatory space in Europe and the US, building new 1inch protocols, expanding the utility of the 1INCH token and scaling up the contributor team.
In an increasingly fragmented DEX landscape with a wide array of chains, sidechains, rollups and their corresponding fee structures, liquidity and slippage, the 1inch aggregator offers a single interface that automatically finds the best price for a given trading pair across multiple sources of liquidity. But it is more than just a comparison shopping engine. The 1inch ecosystem is composed of:
The 1inch Wallet
The 1inch API
The 1inch Aggregation Protocol (DEX aggregator)
The 1inch Limit Order Protocol
The 1inch DAO
The 1inch Foundation
2021 was a busy year for the 1inch Network, with a flurry of innovations aimed at improving the DeFi user experience. Let’s break it down.
Bundling DEXs for Fun and Profit
At the heart of the 1inch Aggregation Protocol is Pathfinder – a routing algorithm that finds the most efficient path for a token swap, splitting the transaction into multiple sub-transactions across different protocols and even different order depths within protocols to give you the best rate. The latest version of the protocol enhances an already long list of optimizations with a range of innovations.
Beyond optimizing swap rates, Pathfinder can also reduce the probability of failed transactions thanks to its partial and dynamic fill mechanism. When a user submits a swap, Pathfinder first splits it between multiple liquidity sources. If during the process the rate on one protocol changes unfavorably, that particular branch of the route can be canceled, and only the favorable branches fulfilled. Further, dynamic fills will even allow the amount from the unfavorable branch to be redistributed across favorable branches, and the swap can be fully completed at the rate advertised in the interface. Users can also choose to optimize for the best rate or the lowest gas fee (up to 40%) – causing Pathfinder to modify its routing accordingly. All of these options can easily be toggled from the swap interface.
With code optimizations in the latest V3 version of the 1inch Aggregation Protocol, 1inch has become one of the most efficient decentralized swap solutions.
Since late 2020, the protocol can also utilize collateral tokens in its routing, such as those minted on Aave and Compound. Such tokens need to be packed or unpacked to be used in a route – and this is done automatically by 1inch for the user, under the hood.
Bundling is one of the oldest business models on the internet, and the 1inch contributors team has demonstrated exceptional execution skills in building out their business. Few projects can claim the laundry list of both liquidity sources and optimizations that 1inch offers through its single interface, resulting in a healthy order flow across all the platforms 1inch operates on.
User growth has also been rapid, with returning users being roughly matched by new users month-on-month.
Unbundling the 1inch AMM – Zero-Fee Limit Orders
1inch also offers its own centralized swap offering with a zero-fee limit order functionality. Most AMMs today offer only market orders which means that once the user places the order, it is executed immediately at the available market price. A limit order is a standing order to execute a swap only when the market reaches a predetermined price or better – typically used by more advanced traders who are able to analyze the market and assess the probability of reaching the limit price.
When a user places a limit order, it is added to a centralized database managed by 1inch. These orders can then be filled by any other user, including CEXs and the orders created by Pathfinder in the aggregation protocol. Takers of limit orders cover the gas costs in addition to the trade’s value, which means this is a zero-fee order for the user. The implementation also allows dynamic pricing, conditional offers where users set conditions for execution and Request for Quote (RFQ) offers for specific order sizes.
This functionality unlocks a host of features. Stop-loss orders, which automatically close when the price limit is reached, trailing stop orders, where the limit is set to ‘trail’ the market price by a fixed amount if it rises, and remain unchanged if the price drops, and auctions such as Maker DAO auctions where the price is dynamically set according to the best bids for a specific order size.
The version 2 of the 1inch Limit Order Protocol also facilitates gasless limit orders for ETH, enabling users with zero ETH balances to swap supported tokens. This significantly lowers the barrier to entry for new/first-time users. Other improvements include DAI-like permits extended to more tokens, optimized RFQs and others.
Unbundling specific functionalities (order types in AMMs) and building on them to offer a unique selling proposition is another tried-and-tested business model that 1inch has executed well on, with Ethereum volumes projected to cross 800 million in January 2022.
Unbundling Liquidity with the 1inch Liquidity Protocol
You can earn tokens by participating in 1inch liquidity mining programs and locking LP tokens in pools. While this may seem like any generic AMM, 1inch has an innovation to offer here as well: virtual rates, which are a form of protection against ‘front-running’ attacks.
Front-runners (miners or bots, primarily) observe transactions that are broadcast by a protocol, and insert their own transactions before they are finalized for profit. In AMMs, when a user swaps token A for token B, the amount of token B decreases in the pool compared to token A, becoming more expensive against A. A front-runner can exploit this to change the exchange rate before the user’s transaction by inserting a similar swap before the user in the next block. The two trades execute, and the price for B availed by the front runner is now guaranteed to be less than that after the user’s trade, as both trades successively increase the price of B. This allows them to then sell B back to the pool, with a profit in token A. Sandwiching ‘true’ swaps with such transactions repeatedly can result in large profits for front-runners. The user ends up with a higher rate for B since the front-runner pushed the price up by inserting their swap before the users trade.
Virtual Rates discourage front-runners from such attacks on 1inch liquidity pools. Following a swap, the swap rate changes only for further swaps in the same direction. For swaps in the opposite direction following such a trade, the rate is a virtual rate that matches the previous swap, as opposed to reflecting the true rate dictated by relative volumes of the assets – preventing front-runners from driving the price up and then profiting from the reverse swap. The virtual rate is in effect for a ‘decay period’ following a successful swap, is governed by 1inch DAO participants, and can be set from 1 minute to 5 minutes through direct governance actions.
The 1inch DAO
1INCH token holders can vote on protocol parameters and governance proposals by staking their 1INCH tokens in the governance protocol. The DAO is being implemented in two phases, the first of which kicked off in December 2020. In this phase, the 1inch Foundation distributed 1INCH tokens to community members through ‘incentivization activities’ according to a lockup release schedule. The initial, core community is expected to implement DAO-based governance in an efficient manner while the protocol governance process is stabilized.
The second phase is now underway, which will enable full-fledged control over extended governance mechanisms, and a treasury – as governed by this 1IP. Voting power is bestowed by holding st1INCH (non-transferable ERC-20 tokens representing 1INCH tokens staked in the protocol’s governance contract), and v1INCH (representing backer/advisors/core contributor 1INCH tokens locked in the vesting contract) which have 1/5th the voting power of st1INCH tokens. Both of these can delegate their voting weight to other addresses.
Currently, one address belonging to Binance has around 10% of the voting power, with the next highest being around 6%, as declared on the governance page.
This concentration of power is due to the 1INCH staking pool on Binance, and is not an individual whale holding 1INCH tokens. The 1inch team is waiting for community contributions and other categories to catch up with the core contributors and have a more even distribution – taking us to the next topic, the 1INCH token.
The 1INCH Token
The 1INCH token has two uses: as a utility token, 1INCH is used in the liquidity protocol to achieve high efficiency routing. As a governance token, stakers of the token will be able to govern the protocol.
The 1inch community will hold 30% of the total supply of tokens, which means that after the vesting period, the majority of the voting power still lies in the hands of the core team, backers and investors. 8% of the 14.5% given to the Network Growth Fund was given to investors in the latest funding round.
The 1inch Foundation
The 1INCH token is issued by the 1inch Foundation, a non-profit dedicated to fostering the 1inch Network and community. It does so by engaging early adopters and growing the population of users staking 1INCH for governance, issuing grants to developers building on the 1inch protocols and yield farming initiatives designed to incentivize liquidity provision across the ecosystem.
Competition
1inch is the dominant DEX aggregator on Ethereum, with more than $130 billion of volume. On both Ethereum and Polygon, 1inch is locked in a battle for supremacy with the 0x protocol (Matcha is the 0x aggregator Dapp).
Ultimately, this is a game of bundling execution, which will be won on the parameters of fees, liquidity, availability of trading pairs, and importantly, integration of other Dapps and Protocols. Within this design space, some tradeoffs are possible. Aggregation can happen not only at the DEX/Dapp level, but also the network level. Since the competitors are essentially aggregating the same DEX’s and Dapps across chains (at least eventually), this space is ripe for commoditization, with those attracting the most liquidity and offering the lowest fees winning out. Execution and speed of adoption and expansion will be the key drivers for success, and 1inch is well placed to remain dominant in this space for the time being.
The Way Forward
1inch has demonstrated remarkable ability to extract capital efficiency out of the DEX ecosystem, and great execution both in terms of user acquisition as well as fund-raising. The rise of the alternate L1s, however, opens up a new horizon for growth, in two dimensions. The first is merely expanding the list of available DEXs and trading pairs. Indeed, 1inch has just expanded into the Avalanche and Gnosis chains in 2022. The other, more complex path is through cross chain swaps. One example is simply to incorporate multiple chains and L2’s within the pathfinding algorithm. Another example is cross-chain staking – where a user can buy a token through 1inch in one chain, and earn staking rewards from another. Technical concerns from Vitalik Buterin notwithstanding, the multi-chain universe represents a new frontier for 1inch to take their bundling and unbundling prowess to new heights.
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