A Crypto Pragmatist Deep Dive: Integral Size

Disclaimer:

This is a new kind of post for us: a sponsored deep dive in which we go in depth on a protocol we’ve partnered with and explain to you how the project and protocol works. It represents no endorsement to purchase the token of the project mentioned below, nor is it an endorsement of the product. It is simply an educational primer on the products and history of a specific crypto protocol, in this case, Integral Size.

You can see our entire crypto portfolio disclosed here and our piece on how we manage our advisory token allocations here.

(This is a 15-minute read)

Crypto is still in its early days–and that means that there are still plenty of problems to be solved.

Scaling, liquidity, regulation, and user interfaces all represent fertile ground for experimentation and growth. Problems exist within these areas because crypto is still a highly immature industry. Decentralized Finance is still largely unsophisticated. Why? The capabilities of blockchains are limited; thus projects have to make compromises in functionality.

Integral Size, the protocol we’re chatting about today (they paid us to write this piece, although we lay out our honest opinion below), is a project directed at improving the way liquidity is utilized and organized in DeFi. If the last few years have been about developing the core infrastructure that DeFi uses, then SIZE is about honing and refining that model. SIZE is an upgrade, a layer sitting on top of the rest of DeFi, which attempts to solve problems in a new and novel way.

The core thesis around SIZE? Efficiency. Usability. Competition. Utility for all stakeholders. And that requires functionality.

So what is the fundamental utility that SIZE offers?

The 1st DEX to offer TWAP execution and 0 price impact trading for any order size
The 1st DEX to offer complete MEV protection
The 1st DEX to offer impermanent loss protection for liquidity providers

Wow–bold claims, and with the advisors they have on board, it seems worth a look to check out SIZE in a bit more depth.

But since SIZE is built as an improvement on other projects in the space, we must first look into those projects (and the problems they present) before understanding SIZE’s innovation and true utility. And it starts by understanding a single core concept: liquidity.

Understanding Liquidity

What is liquidity? It’s the ability for an asset to be sold into the market at a given price. Let’s explain.

Most centralized exchanges (in both crypto and traditional finance) work by using an orderbook system. It takes sell orders of a given price, and matches them with buy orders of a given price. If you want to buy ETH for $1335, you put in an order, and if a seller wants to sell at that price, the order goes through. Same thing on the upside–if you want to sell 1 ETH at $2000, you put in a sell order, and if the price climbs to that price, the order will execute. Every seller gets matched with a buyer and vice versa:

Let’s suppose the price for 1 ETH is $1335. You’ve got 1 ETH, and you send it to Coinbase to sell. The price there is $1335, so you press ‘sell’ and receive $1335. There was enough liquidity for there to be no price impact.

But what if you have 10,000 ETH? There are a limited amount of buyers of ETH at $1335, so if you sell, the liquidity available is below that price. You might be able to sell 4000 at $1335, 3000 at $1299, and 3000 at $1200–but there isn’t enough liquidity available to sell your entire order at a single price. Thus the end result is a lower average selling price–you get less money per ETH.

The takeaway: asset liquidity is a function of demand and supply at the current price.

AMMs

Automated Market Makers are crypto’s response to TradFi orderbooks, revolutionized by the decentralized exchange Uniswap. Instead of an orderbook-style two-party system (one buyer, one seller), they introduce a different counterparty to the transaction: a so-called ‘liquidity provider.’

The liquidity provider’s role? They place an evenly-valued ratio of two assets (we’ll use apples and bananas in this case) into a liquidity pool.

Let’s say I want to earn income on my apples and bananas: I throw 50 bananas and 50 apples into a Uniswap Liquidity Pool. When a trader comes along, he can trade either asset for the other one. But every trade affects the price of the swap: see the GIF below.

As you can see, when people want apples from the basket, they need to deposit bananas to keep a balanced basket. But as the amount of apples in the basket rise, the ratio of apples:bananas decreases. The effect of this on the original providers of apples and bananas can be understood by the following.

If I put my one apple and one banana into the pool at the beginning and I’m ready to take them out, I would find that my share of the pool has changed from one apple to .25 of an apple, and my one banana is now 2 bananas.

Let’s extrapolate this curve to crypto: the ETH–USDC pair on Uniswap. The pool allows people to always trade ETH in the pool for USDC, or vice versa. The liquidity provider (LP) is effectively indifferent to the two assets in the pool, and collects a small fee from every trade.

Over time, fees ideally offset the price movement from ‘passive’ liquidity, as the downside to providing liquidity is the fact that, by default, you end up with MORE of the asset that goes DOWN in price, and LESS of the asset that goes UP in price: this is called ‘impermanent loss,’ and it can make LPs lose a lot of money over time, especially if the two assets in the pool are uncorrelated.

Finally, the bigger a swap is, the more expensive it becomes for the trader (just as we outlined with the 10,000 ETH sell order from above). This is a function of ‘slippage,’ or the way that bigger swaps move price proportionally more than smaller swaps. This problem is exacerbated on Layer Two networks, which generally have less liquidity than Ethereum’s Mainnet.

To review, here are a few problems that AMMs present:

AMMs create higher price impact for orders (especially big ones)
AMMs lead to impermanent loss for Liquidity Providers
AMMs lead to MEV that often extracts value from users

Over-The-Counter Desks

One solution to this liquidity problem? OTC (Over-the-counter) Desks, which will quote a single, specific price for any digital asset they decide to list. These brokers source liquidity from different venues (CEXes, DEXes, other counter parties) to quote a single price. The counterparty can take it or leave it.

Sometimes exchanges and Over-the-Counter desks offer a service called TWAP, or Time-Weighted Average Price. These algorithms attempt to fill an order with the best average price over a specific time period instead of creating a massive buy/sell in one specific moment.

This is how most institutions, funds, prop trading shops, and whales trade, but there are a few problems with this:

OTC desks provide a price below the ‘market’ price
OTC desks are not accessible to smaller traders

Addressing MEV

There’s another problem with passive liquidity: MEV, or Miner Extractable Value. MEV refers to the profits a miner can collect for rearranging a specific block in the chain. While we won’t get into the deepest intricacies of MEV today, it’s important to note that its flow is generally toxic. MEV doesn’t just eats into the profits of liquidity providers, it also generally makes token swaps more expensive for traders via sandwich attacks, frontrunning, and backrunning.

Wildly enough—you might have lost money to MEV without even realizing it.

Tl;Dr: MEV literally extracts value from market participants and distributes it to Miners (and searchers). The bigger the transaction, the more value can be extracted, taking money out of traders and DeFi users.

Let’s come back full circle and define some of the current problems with DeFi:

AMMs create large price impact, especially for larger orders
AMMs create impermanent loss for liquidity providers
OTC desks are inaccessible and quote a lower-than-market price
MEV extracts value to third parties

The Solution: Integral Size

Integral Size picked a quite elegant solution to deal with many of the problems token swaps face. But instead of building a new product, they built on top of existing DeFi primitives. Integral Size’s product, the SIZE DEX, addresses them all. How?

The basic mechanics of Integral Size are actually quite simple:

You send an order in for a specific crypto asset using the SIZE DEX
The DEX takes the average price of that asset over a 5-minute time period on Uniswap
They fill your order for that specific time-weighted) price

Essentially, you place an order for a given cryptocurrency, then, after a small delay, the protocol calculates an average price over the agreed-upon time period based on the observation of Uniswap. You get your order back for a (hopefully improved) price over what you would’ve gotten on a standard DEX. SIZE takes 1 basis point for performing the service.

A simple and understandable mechanism–so how does it improve on the problems related to transacting on DEXes?

TWAP-based pricing becomes accessible to any user, not just whales
There is no price impact due to AMM slippage–the quoted price is the price you get
Impermanent Loss is minimized because toxic MEV trades are eliminated
The platform is permissionless, anyone (including DAOs) can use it
MEV is entirely eliminated

It’s not a perfect solution, however:

LPs can still lose money due to impermanent loss
The solution still requires third-party Liquidity Providers to put up capital

Meaningful improvements for a project that’s just starting out. Who benefits?

1. SIZE is a DEX for Whales

Integral offers SIZE as a custom-built DEX that serves crypto whales and their large orders in the most efficient manner. Integral SIZE serves whales in the following use cases:

On-Chain OTC swap mechanism with zero price impact
Tool to transit between various DeFi tokens
Channel for swapping GameFi tokens, NFTs and Pool 2 farming
Venue for liquidity farming without toxic order flow

SIZE provides whales with an on-chain OTC swap mechanism where their large trades can be executed at TWAP, resulting in zero price impact during liquidation events.

As we’ve witnessed during a recent period of sharp price volatility (down days and liquidity crunch on other venues), a segment of traders couldn’t source liquidity in the CEX market. A trader from this segment submitted trades in multiples of 500, 100 and 2,000 ETH from a FTX hot wallet to a wallet which eventually sold ETH on Integral. Example

Whales can also leverage SIZE as a way to transit between DeFi tokens. As we see in this example, a heavy DEX trader swapped 880k DAI from AAVE for USDC on Integral then continued to stake it on DYDX.

SIZE can also be used as a channel to swap GameFi tokens as we saw in this example where an Axie Infinity farmer traded $43k in ETH for $USDT.

In addition to enjoying the benefits and savings of large trades with zero price impact, whales can yield farm on Integral SIZE with zero impermanent loss.

2. SIZE is a DEX for OTC Swaps

Integral offers a DEX that functions as an OTC protocol for large order token swaps. While it has formerly been entirely inefficient to perform token swaps on-chain, fair pricing for crypto-native traders is available with SIZE’s new mechanism.

OTC trading has formerly been gated to institutions and whales, while SIZE opens a new, efficient trading venue for any trader of any size. In many cases, in fact, it will likely give a better price for a given token than you can get from any other venue.

3. SIZE is a DEX for DAOs

Integral offers a custom-built DEX that serves DAO treasuries. It provides DAOs with the most efficient mechanism to swap tokens that is native to their decentralized structure and ethos. Integral SIZE was built to serve DAOs by acting as an on-chain OTC venue allowing DAOs to:

Actively maintain and grow the value of their treasury funds.
Execute large swaps through Gnosis Safe.

A DAO use-case for Integral SIZE would be something like the $15m CVX purchase by JPEG’d DAO. Integral SIZE can be used by DAOs to bootstrap liquidity with no impermanent loss. For DAOs that hold stablecoins, SIZE can be used to rebalance or acquire ETH for its reserve.

Ultimately, Integral SIZE serves DAOs as an on-demand OTC planform where governance tokens can be sold without incurring price impact. DAOs can deposit tokens into SIZE as an LP and allow those tokens to be swapped at a 30-min TWAP execution.

An example that illustrates this hypothetical case study is by analyzing large trades for the SUSHI token–a pool that launched on Size. With millions of dollars volume passing through the pool, it was a success not only for LPs, but for traders who received improved TWAP execution and zero slippage.

Weaknesses

Every project comes with tradeoffs, Integral Size is no different:

SIZE’s network effects are weak: As a small project, SIZE is just starting out in their effort to improve on-chain trading. But liquidity is a game of network effects, and SIZE still relies on pulling in new participants to have deep-enough trading liquidity to be worth it for users to come over to trade in size.
Effective competitors exist: For the most liquid venues in crypto, including CEXes. Product-market fit might come easiest for anonymous whales, DAOs, and for projects not listed on CEXes–people that are required to trade on chain
LPing Issues: Liquidity provision on SIZE has benefits and drawbacks–sure, LPs are no longer exposed to MEV flow, but they’re also subject to lower volume and fees than the most popular DEXes. The consequence of this is that LPs will likely need to be incentivized using other tokens from partner projects or from Integral Size themselves.

The good news? The product is compelling for a specific group that will likely represent a larger and larger chunk of the crypto market: if Integral Size becomes the best venue to trade on with the best prices, the other difficulties with the platform will likely get sorted out as network effects increase.

Actionable Items for You:

So what does this mean for crypto traders? It depends who you are, and a wide swath of users now benefit from this new tech:

Retail users/degens can now finally enjoy on-chain TWAP execution without paying excessive gas fees.
DAOs and pro traders can now trade on-chain efficiently. For DAOs, Gnosis safe adds a whole new layer of utility: the Gnosis Safe App was recently integrated, which allows DAOs to perform trades on Integral SIZE via Gnosis Safe.
Layer Two users can access both TWAP and Concentrated Liquidity technology from Integral will accelerate the liquidity growth on L2 with SIZE. Efficient liquidity creates more capital efficiency on L2 networks as well.

Whether you’re a whale, institution, retail user, or DAO participant, there are fundamental improved use cases for most crypto users.

Other ways to benefit? LPing trading pairs will let you collect trading fees from all of the activity that goes through the network. It seems likely that many tokens would benefit from setting up a trading pair on SIZE–look for future partnerships as well with DAOs looking to set up trading pools and with DEX aggregators looking to integrate with the platform.

Playing the Ecosystem:

With a breadth of products available, Integral Size is a fresh application on Arbitrum worth playing around on. Consider the following:

Learning about yield farming: Integral Size’s new yield farming program starts tomorrow and will be the base of some juicy rewards worth checking out. More volume to the pools will obviously boost the APRs available, so if Integral Size can attract meaningful volume on Arbitrum, it could be a prospect worth evaluating.
Using the Product: No DeFi product will ever be successful until it can boast massive adoption. When you’re purchasing ETH on-chain, consider either swapping on Ethereum or Arbitrum. Admittedly, the bigger investor you are, the more sense it makes to use Integral Size. When we tested liquidity on Arbitrum, an investor can save $8 on a $1000 purchase using Integral Size, $80 on a $10,000 purchase, but after approaching the $1m mark, up to $50k. Effects amplify with bigger orders.
Understanding the Token: To evaluate the viability of the project, it’s worth taking a look at protocol tokenomics and documentation, which can be read here: https://docs.integral.link/size/

Conclusion

While innovation in crypto in recent years has been zero-to-one, we often forget that much of innovation is refinement; the integration of improved, iterative, and incremental layers that make technology accessible. While early automobiles began to come onto the market in the late 1800s, it was the comfortable, widely-available Model T in 1908 that brought cars to the masses. ARPANET was a functional internet, but it took many years of improvement until the consumer internet was widely used in households.

Perhaps crypto innovation and adoption will happen in similar ways: not caused by the big leaps forward (although they are necessary), but by the little incremental steps that help make those big leaps accessible to the masses.