Only Possible On Solana

The saying “only possible on solana” or “OPOS” is a testament to the many advantages Solana has when it comes to decentralized application development. Its fast, cheap transaction fees and smooth UX unlocks capabilities many couldn’t envision 1-2 years ago.

In the DEX space specifically, Solana’s efficiency has given rise to concepts such as automated liquidity strategies (Kamino), orderbooks (Phoenix) and aggregators (Jupiter) - ideas that have been tried elsewhere but with minimal success due to scaling limits.

One ingenious DEX that utilizes the strengths of Solana’s scaling capabilities and extensive ecosystem better than anything else is Lifinity. And it seems to have gone somewhat under the radar, despite unbelievable capital efficiency and earnings.

The oracle-based AMM

Lifinity is the creation of Luffy and Zoro, two developers with a combined 28 years of product experience and 6 years of market making experience. Like most DEXs, Lifinity applies liquidity to an automated, concentrated xy=k model as opposed to an order book with market makers.

However, unlike most DEXs, it does not rely solely on the xy=k curve to determine prices, but rather uses oracles to prevent the impermanent loss dilemma that plagues AMMs today. To further illustrate, below is an excerpt from Lifinity’s debut medium post.

The critical drawback of AMMs is impermanent loss, which is a symptom of their dependence on traders adjusting their price rather than them determining their own price the way a market maker would. This creates a dynamic where an AMM’s price routinely lags the market, enabling arbitrageurs to capitalize on the spread at the expense of the liquidity providers.

But by basing prices via oracles rather than its pools’ ratio of assets, Lifinity is able to offer prices in line with the market, preventing arbitrageurs from eating their lunch, so to speak.

What does this enable?

Oracle-based pricing allows Lifinity to apply algorithmic trading concepts that emulate the methods market makers use. Done right, they can go from getting their lunch eaten by arbitrageurs to eating the lunches of their biggest competitors, Raydium and Orca.

To understand how this works, we first need to understand how most orders on Solana are executed. Unlike other ecosystems, where users trade directly on a DEX like Uniswap, most traders on Solana use a DEX aggregator called Jupiter. Jupiter, because of Solana’s cheap fees, is able to split up transactions and execute them across multiple DEXs to give traders the best prices with the lowest slippage. Jupiter itself is an example of OPOS.

What this means is DEXs don’t have to source their own volume, but instead have to directly compete with one another to offer the best prices with the lowest slippage. This allows Lifinity to use its informational advantage via oracles to “outsmart” and frontrun its competitors.

How Lifinity does this is by comparing the price of the oracles to the price of other AMMs (Raydium, Orca) to not only match the oracle price, but position themselves on the opposite side of the amms. Typically, in a scenario where SOL is falling in price, traders are net selling their SOL for USDC causing AMMs to accumulate SOL as the price depreciates. Lifinity on the other hand, adjusts their price of SOL to be lower than other DEXs so that sellers get the worst rate and buyers get the best. This means that as traders make moves on Jupiter, only the buy trades route through Lifinity, while the sell trades route through the other DEXs. Therefore, Lifinity accumulates USDC rather than SOL, inversing the AMMs.

Once the selling is over and the price settles, the oracles and AMMs once again show similar prices. At this point, Lifinity has significantly more USDC than SOL in its pool and has to rebalance to a 50:50 ratio, meaning it buys SOL at its potential pico bottom. This allows Lifinity to have both more USDC and SOL than before as it bought SOL at a lower price than it sold at.

If SOL then rebounds, Lifinity does the opposite and offers buyers the worst price and sellers the best price, allowing it to wholly earn the price appreciation of its newly bought SOL while accumulating SOL rather than USDC. The profit it earns through this process is labeled “market making profit” (MMP).

To further illustrate this point, below is an excerpt from its initial testing results in February, 2022.

As mentioned elsewhere in the test results, AMMs are typically short volatility as they accumulate the worst performing asset between the pair. However, Lifinity is long volatility as it accumulates the best performing asset and frontruns the AMMs the way an arbitrageur would.

Performance/Traction

If you look through its monthly updates and pool aprs, the returns are consistently staggering. Lifinity not only routinely outperforms other AMMs, but outperforms holders of the pool’s assets, even when excluding the trading fees it earns. Below is a graph showing Lifinity’s primary SOL-USDC liquidity pool performance vs holding 50% SOL and 50% USDC. This pool, in less than a year and a half, has managed to 13x in performance vs the holdings themselves.

Furthermore, with its unique mechanisms, it’s able to maintain incredibly thin liquidity ranges, so much so that it’s achieved $20B in volume YTD with less than $20m in TVL, setting a new bar for capital efficiency.

In fact, it’s so efficient that its sol-usdc pool is Jupiter’s most used pool seeing well above $500m in weekly volume. Its sol-usdt pool is 4th, well above any other sol-usdt pool in Solana.

Tokenomics - Protocol Owned Liquidity

The Lifinity team could’ve concluded their vision at “oracle-based AMM” and called it a day. However, they addressed another crippling failure of today’s DEXs that turns Lifinity from a great product to a great investment.

Today’s DEXs have terrible tokenomics. The reason they release tokens is to boost yield for their liquidity providers (LPs). By boosting yield, they can help LPs overcome their impermanent loss and can attract further liquidity by providing better yield than other DEXs. This obviously creates an unsustainable model where the DEX needs to keep emitting tokens to sustain liquidity. This also makes it difficult for DEXs to take a cut of the trading fees as LP’ing is already on razor thin margins.

Fortunately for Lifinity, it doesn't suffer from impermanent loss, at least not to the degree of their competitors. So it doesn't need to inflate its token to remain afloat. Furthermore, because of its tight spreads and rebalancing mechanism, it doesn't need a lot of liquidity to offer competitive prices.

Because of this, Lifinity is able to do two things. First, it doesn’t source liquidity from LPs but rather owns its own liquidity, known quite simply as protocol owned liquidity (PoL). By doing so, it earns all of the trading fees instead of having to share it with liquidity providers. Second, its token, $LFNTY, is not an inflationary, yield boosting product, but a fundraising tool with sustainable utility. In order to raise the funds to provide its own liquidity, it sells its tokens at a discount with a vesting schedule. With the trading fees it earns using the liquidity, 50% goes to stakers of the token, 40% goes to token buybacks and 10% goes to the team, giving $LFNTY a clear, sustainable value accrual mechanism.

With the market making profit it earns, the proceeds initially are reinvested into the pools to increase liquidity. However, once tvl reaches a certain point where additional liquidity produces marginal gains, the excess will be realized as earnings and distributed similarly to the trading fees.

Of the 100M tokens, 20M were sold at TGE to bootstrap the initial liquidity. Another 20M was allocated to the team, 1M to Lifinity’s NFT collection and 59M to the DAO. There is no VC involvement/allocation. At the moment, 35M tokens are circulating, of which, 27M are staked using a vote escrow (VE) model to earn the trading fees.

Despite the 3:1 FDV to market cap ratio, the inflation rate is minimal, limited only to the team’s allocation, of which 11M tokens remain unvested. The DAOs holdings, currently 52M LFNTY, is reserved for raising further liquidity in order to increase scale. In the event where a fundraise takes place, inflation would be offset by a significant increase in book value and its ability to process more volume. Therefore, I believe token inflation is a negligible concern and could contrarily drive price appreciation as the emissions would directly improve the project’s fundamentals.

Price analysis

Determining a fair valuation for Lifinity is relatively straightforward. Just figure out the fees it earns, annualize them, and compare them to the price to get an estimated P/E. The main complexity comes from whether market making profit should be considered as earnings when it’s being reinvested as opposed to distributed to holders. Although traditionally it would be included as retained earnings, Lifinity doesn’t include it in its revenue metrics so I won’t either.

The current price of LFNTY on April 30th, 2024 is $1.40 with a market cap of $50M and FDV of $140M. Year to Date, as shown in the graphic below, Lifinity has earned $4.9M in trading fees, which annualizes to $14.7M. If we account for 10% of the revenue going to the team, that leaves $13.2M in earnings accrued to holders via yield and buybacks.

When compared to the market cap, this nets a P/E of 3.79. When compared to FDV, the P/E is 10.61. Considering the growth potential of Solana DeFi, the prospect of earning excess market making profit and the ability for token emissions to accrue value to the protocol, LFNTY seems heavily undervalued.

Catalysts - When Solana Wins, Lifinity Wins Big

The “Only Possible on Solana” narrative has been a prominent one over the last year, and Lifinity is a great example of that. Not only is it only possible on Solana, it also makes money from every narrative that Solana sees.

During the recent meme coin run, Lifinity was a top 3 DEX for both WIF and BONK. Furthermore, often when traders bought a meme coin on Jupiter using USDC, Jupiter would first route through Lifinity to swap to SOL before purchasing the memecoin. As mentioned earlier, Lifinity’s SOL-USDC pool remains as Jupiter’s most used pool across all AMM’s.

This means as Telegram bots, AI agents and now Coinbase themself integrate Jupiter in their backend, they’re integrating Lifinity. It is the ultimate pick and shovel in Solana.

Catalysts - Pendle on Solana

One overlooked development that’s being closely guarded by Solana bulls is the upcoming launch of a Pendle on Solana. With Sanctum’s recent breakthrough in LST liquidity, allowing for validator specific LSTs, demand for yield trading is growing. And once again, the Lifinity team is there to capture the value, as they are the ones building the Pendle on Solana, known as Sandglass.

Currently in beta, Sandglass is using a portion of Lifinity’s POL to bootstrap their first pool, mSOL, and conduct testing. In return for using this liquidity, the team plans to reward Lifinity holders, presumably via a portion of Sandglass’s tokens. The current FDV of Pendle is $1.1B with a TVL of $4.1B. If Sandglass is able to capitalize on Sanctum’s momentum and amass significant TVL, it should be able to attain a strong FDV and reward LFNTY holders handsomely.

Limitations

Although Lifinity is, in my opinion, an s-tier project, it’s not without its drawbacks.

The first is its dependance on oracles. Although Pyth is as reliable as it gets in the industry, it and other oracles are subject to mispricings, especially when market manipulation or low liquidity assets are involved. In general, I’m of the opinion that oracle-based products are easier to game than oracle-less ones.

The second is the rise of order books within the Solana ecosystem. Because of Solana’s speed and affordability, order books are more viable than in other ecosystems. And we’re beginning to see their prevalence with Open Book and Phoenix. The problem order books pose for Lifinity is that they’re much more efficient than Orca and Raydium.

Right now, Lifinity earns much of its revenue through market making profit, where it skews its prices to take the other side of its competition’s losing trades, aka impermanent loss. But if it has to compete with order books and the professional market makers that utilize them, it could have a difficult time outcompeting.

My expectation is that AMMs will continue to see the majority of DEX volume for the next 1-2 years, especially with swaps, however as order books increase in market share, Lifinity’s market making profit may deteriorate. I expect its volume and trading fees to maintain their trajectory, however.

Conclusion

When analyzing the “only possible on Solana” narrative, it’s important to look for projects that utilize Solana’s capabilities to unlock new mechanisms and its ecosystem to position themselves for meteoric success. Lifinity may be the best example of that.

Lifinity’s repricing and rebalancing mechanisms, alongside its industry leading capital efficiency are only possible through the efficiencies of Solana and Pyth. It also takes advantage of the most effective and dominant DEX aggregator to capitalize on DeFi’s biggest inefficiencies - impermanent loss and poor liquidity management. And then through thoughtful, innovative tokenomics, it brings those benefits to the holders.

As Solana continues to prove the naysayers wrong, positioning itself for mass adoption, Lifinity will be there to make the most of it.