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Automated Market Maker in the NFT market? How does Sudoswap work? Understanding the mechanism, advantages, and disadvantages in one article

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Automated Market Maker in the NFT market? How does Sudoswap work? Understanding the mechanism, advantages, and disadvantages in one article

The well-established NFT over-the-counter trading market Sudoswap launched sudoAMM in early July, a new NFT trading mechanism that enhances liquidity in the NFT market through a feature similar to Uniswap V3. This article will introduce its underlying mechanism and usage instructions, and discuss its current advantages and disadvantages based on personal experience.

Sudoswap Emerges from the OTC Market

Sudoswap was initially created by 0xmons as an NFT over-the-counter trading marketplace launched in April last year. Users can engage in composite trading of ERC20, ERC721, and ERC1155 tokens, have control over counterparties, expiration dates, and incur no trading fees or royalties.

In early July this year, Sudoswap introduced SudoAMM, a decentralized liquidity AMM protocol designed specifically for NFTs, with liquidity pools consisting of NFTs and tokens, currently supporting only ETH. Users can buy or sell NFTs through the liquidity pool.

Most mainstream NFT trading markets operate on a peer-to-peer basis, using limit orders. Buyers can browse listed prices from sellers and make offers on NFTs of interest or directly make a purchase based on the seller's offer.

The biggest drawback of this type of trading is that sellers cannot instantly transact, which may lead to selling assets at a loss if they wish to expedite the sale process.

NFT Trading Mechanism Similar to Uniswap

So, what sets SudoAMM apart? As mentioned earlier, its trading is carried out through liquidity pools composed of NFTs and ETH, similar to the process of trading on Uniswap. Users can not only exchange NFTs for ETH and vice versa but also act as liquidity providers (LPs).

When creating a pool, liquidity providers can choose to provide single-sided or double-sided liquidity. Providing NFTs as liquidity earns ETH, and vice versa. In the case of double-sided liquidity, the NFT price changes with the pool ratio, allowing liquidity providers to earn a portion of the trading fees with each transaction.

However, with most NFT projects having fewer than 10,000 items, using Uniswap's constant product algorithm x*y=z for liquidity pools can lead to significant slippage due to insufficient single-sided liquidity.

Referencing the official documentation from Sudoswap:

For instance, if a liquidity pool consists of 10 NFTs and 10 ETH, following the x*y=z constant product algorithm, which is 10*10=100, the price for buying or selling NFTs in this pool would vary as follows.

After multiple trades, if there are too many or too few NFTs in the liquidity pool, the price discrepancy becomes significant. When the pool has 10 NFTs, the purchase price is 1.111 ETH, but with only 2 NFTs left in the pool, the purchase price skyrockets to 50 ETH.

Therefore, Sudoswap's liquidity pools employ a different algorithm that abandons the constant product rule and instead uses a simple pricing function, including linear and exponential curves.

With the linear curve pool, the NFT price moves a fixed amount with each trade, while in the exponential curve pool, the NFT price is multiplied by a fixed percentage with each trade.

The following image illustrates an example of an exponential curve liquidity pool where a pool of 10 NFTs and 10 ETH, with each trade, the NFT price is multiplied by 1.1.

Thus, when there are 10 NFTs in the pool, the purchase price is 1 ETH, and even if there are only 2 NFTs left in the pool, the purchase price would only rise to 2.144 ETH, a significant decrease compared to the earlier example of 50 ETH.

However, how does Sudoswap's approach of providing narrower price ranges differ from Uniswap v3?

The official explanation provides two points:

  1. Efficiency: In SudoAMM, native NFTs are paired with ETH, eliminating the need for additional NFT conversion fees and saving on Gas Fees.
  2. Flexibility: LPs can adjust their pool parameters at any time in response to market conditions, such as adjusting the price range of NFTs, the current liquidity pool price, and the percentage of transaction fees charged during buying and selling.

In other words, although conceptually and mechanistically similar to AMMs like Uniswap V3, Sudoswap offers a more straightforward and flexible user experience.

Usage of Sudoswap

After connecting the wallet to Sudoswap, users can access various functions. Below is the process of creating a double-sided liquidity pool.

First, when creating a liquidity pool, click on the rightmost option and choose the tokens and NFT projects to deposit into the pool.

Next, set the parameters of the liquidity pool:

  • Fee Amount: Percentage of transaction fees charged per trade
  • Start Price: Initial price of the NFT
  • Delta: Percentage change in NFT price after each trade

On the right side, set the upper limits for buying and selling. The protocol will calculate the required quantities of NFTs and tokens to be deposited, and users can view the cost and profit of transactions through the slider below.

The chart below displays the price of NFTs after buying or selling transactions.

The final step is to select the NFTs to add to the liquidity pool, confirm the parameter settings, authorize the contract, and the creation is successful.

Additionally, Sudoswap offers the functionality of making collection offers for NFT series, similar to limit orders. Behind the scenes, this involves creating a pool of single-sided liquidity, where users provide ETH and receive NFTs.

As shown below, users can set the purchase quantity, price, and decreasing amount of the offer.

Advantages and Disadvantages of Sudoswap

According to Sudoswap's Twitter, Sudoswap has several strengths compared to traditional NFT markets:

  1. Lower Friction Costs: Sudoswap charges only a 0.5% transaction fee, unlike OpenSea, where each transaction incurs royalties and a 2.5% transaction fee.
  2. Gas Fee Savings: Trading on Sudoswap incurs lower Gas Fees compared to most platforms, particularly noticeable with larger purchase quantities.

However, after actual usage, Sudoswap also has its weaknesses:

  1. Limited Selection of Goods and Projects: As Sudoswap's NFTs rely on liquidity providers, there is a limited selection of projects and NFT types until Sudoswap gains more popularity.
  2. Perceived Homogeneity: When LPs automatically buy NFTs, they cannot assess the rarity and appearance of the NFT, potentially leading to acquiring NFTs they do not personally like.

Continuous Increase in Sudoswap Trading Volume

According to data from Dune Analytics here, since its launch in early July, Sudoswap has accumulated approximately $6.77 million in trading volume, with platform fees totaling only $33,000. Currently, there are over 6,464 liquidity pools and more than 4,000 users.

Although relatively insignificant compared to more established NFT markets like OpenSea and Looksrare, Sudoswap is gradually attracting more attention with the daily trading volume and user growth rates.

In addition, Scott, the Uniswap product lead, seems to recognize the potential of Sudoswap, stating at the end of July that Uniswap's NFT trading market will be launched with Sudoswap's support.

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