A Deep Dive into SushiSwap

What is SushiSwap?

SushiSwap began as a fork of the popular Ethereum based Automated Market Maker (AMM) protocol Uniswap, but quickly became an innovative cutting edge DeFi leader in the space in a short period of time. Although the path Sushi took was unconventional and by no means smooth, it set the precedent for what an innovative platform should be as well as how you can build on top of an existing code base and transform it into something of its own. Today SushiSwap offers an array of products and services such as the staple offering: SushiSwap the AMM, Kashi for lending & borrowing, BentoBox vaults & dApp ecosystem, Miso launchpad, and finally Sushi’s next generation market maker, Trident.  

Adding on to the true nature of decentralized finance, SUSHI, the native token of SushiSwap, can be staked into the xSUSHI or SushiBar contract to earn yield from fees generated by the AMM and voting rights in the DAO. The way SushiSwap is structured is unique; they have a few core contributors that built out the protocol offerings and the DAO can choose which proposals to back. The SushiBar contract earns yield in the form of a 0.3% transaction fee, which is collected in the native LP being transacted in, and then converted to SUSHI daily. The Sushi that is bought back is then distributed amongst stakers into the xSUSHI contract providing a positive feedback loop rewarding the use of the protocol. 

While SushiSwap may have started as a fork of and direct competitor to Uniswap, the protocols serve two very different markets today. SushiSwap’s team has proven their ability to deliver and maintain a first mover advantage by building out an entire suite of products to support a tokens life cycle rather than just solely focus on the secondary market. This has given them a unique position, as they have expanded not only vertically in their product offerings but also by expanding their offerings into both layer 1 chains and layer 2 scaling solutions. This has made Sushi a household DeFi name for active participants and provides a level of trust and comfort when entering a new ecosystem.

Automatic Market Maker (AMM)

To understand what an AMM is, let's first start by understanding the role of market makers in a traditional or centralized exchange. A market maker's role is to provide liquidity to the market by quoting on both the bid and ask side simultaneously, where they aim to make profits on fee rebates and the spread between the bid-ask. Market makers aim to stay delta-neutral (no-directional risk) or carry little delta (slight directional risk) depending on outlook, risk profile, and strategies being employed.

When we look at DeFi and on-chain networks, such as Ethereum, it is not really viable for the traditional trading infrastructure to exist in the form of an order book and market makers. This is due to the latency of the network and the fees associated with transacting on it. So, a new way to facilitate trading around ‘pools of liquidity’ was created, the Automatic Market Maker (AMM). In this new trading mechanic, users all contribute capital to the protocol and get rewarded a percentage of trading fees received based on the amount and volume of transactions done in the pairs being provided. Users must provide capital or liquidity to both sides of the pair. This process is called LPing or Liquidity Pooling. For example, a common trading pair might be SUSHI/ETH, so the user would provide $1,000 worth of SUSHI and $1,000 worth of ETH to the protocol, allowing users to buy and sell between the two pairs. When a trade is performed, the pool becomes imbalanced, as one asset is put into the pool and another is removed, causing the protocol to rebalance to a 50/50 weight. This is a basic example of how a constant product pool functions at a high level.

Brief Origin of AMMs

The introduction of AMMs came with Uniswap, a protocol that allows the listing of pairs and the trading of tokens to be done in a permissionless fashion on top of Ethereum. Originally in Uniswap V1, pools were created against ETH, so all of the swaps were performed in pools structured as such: ERC20/ETH. Uniswap V2 was unveiled in May 2020, allowing pools to be set up for trading between ERC20/ERC20 tokens instead of just ERC20/ETH pairs. Many of the AMMs today are forks of this Uniswap V2 codebase with slight variations to the UI/UX and other tweaks, such as the MasterChef rewards contract implemented by SushiSwap. When referring to a V2 AMM, V2 style, it is simply meaning the constant product pool structure made popular by Uniswap.

Liquidity Pools & AMMs by Finematics

“Basic liquidity pools such as those used by Uniswap use a constant product market maker algorithm that makes sure that the product of the quantities of the 2 supplied tokens always remains the same. On top of that, because of the algorithm, a pool can always provide liquidity, no matter how large a trade is. The main reason for this is that the algorithm asymptotically (converges on infinity) increases the price of the token as the desired quantity increases.” -- Finematics Liquidity Pools Explained

Concentrated Liquidity Pools & Uniswap V3

While we briefly discussed the standard make up of an AMM/V2 and Finematics broke down the constant product formula, V3 takes a different approach to maximize capital efficiency. I highly recommend checking out more technical breakdowns by Finematics like this one to learn more if you don’t understand Uniswap V3 or concentrated LPs already: https://finematics.com/uniswap-v3-explained/

The initial SushiSwap product offering and staple is the Automated Market Maker protocol built on Ethereum, similar to that of Uniswap V2. The AMM is accompanied by a suite of smart contracts that handle reward distributions, overall operations, and governance of the protocol. But that is only a portion of how they've differentiated themselves. Providing a familiar, seamless user experience across multiple platforms was the next step that the team took on, a challenge not many protocols have completed successfully. Currently at the time of writing, Sushi is continuing to innovate and has AMM support for five different layer 1 chains including: Binance Smart Chain, Ethereum, Polygon, Fantom, and the Huobi Ecochain, making it a one stop shop for for performing basic swaps on a large variety of networks.

BentoBox is a vault that can hold ERC20 (and other cross chain) assets and generates yield for its depositors by providing flash loans with the tokens deposited. The platform also allows decentralized applications (dApps) to be built on top of it to leverage the vault in various ways providing a new income source for depositors as well as giving the dApps the flexibility & access to funds in an efficient manner. BentoBox is a new DeFi offering, aiming to house multiple of the core DeFi primitives, making them work together to increase gas efficiency, earn passive yield, and create a more composable dApp ecosystem between products. 

BentoBox itself consists of one or multiple main vaults that house the assets. Because the dApps built on top of Bento are all interacting from these main vaults, there is no need to re-approve asset transactions each time, as assets are already approved for the entire vault. On the same note, the interactions between the dApps and vaults cost minimal gas, as they have lower computational costs versus interacting with dApps from an outside wallet. After depositing into the protocol, users are able to earn passive yield on their assets through flash loans that are lent out and other approved strategies through governance, such as utilizing dApps built in within the bento box, as well as dApps, such as CREAM or Compound vaults etc. Bento aims to be an ecosystem where anyone can lend or LP, and dApp developers can build within it using its vaults and efficiency in a permissionless way. This is an interesting approach, as many platforms try to create ecosystems on the Layer 1 level but find that protocols quickly become fragmented. The Sushi team has chosen to attack this at the protocol level and create a robust ecosystem that way to ensure composability and efficiency.

Kashi is a lending and borrowing platform that allows users to select two tokens — one for lending and one for collateralization, creating an isolated pool for these pairs. Typically, lending platforms like Aave and Compound employ shared pool-based lending, which makes the riskiest asset the weakest point on the protocol — this is why Aave and Compound don’t list many assets. Kashi uses isolated pools in place of cross collateralization within the entire lending protocol, which has its strengths and weaknesses. With cross collateralization, you can freely lend out and borrow any assets against others, as long as the protocol accepts the collateral and issues the desired assets. The main concern with this style of collateralization is that if an asset were to depreciate faster than the loans can be deleveraged by the liquidation mechanisms, it could result in losses to the entire user base, which would either have to be socialized or absorbed by the protocol insurance fund. 

The main safeguard against this is maintaining a high Loan-to-Value (LTV) ratio, which is effectively reducing the on-chain leverage, as well as maintaining a selective scope of assets that can be used as collateral. The Kashi platform uses a different approach in isolated pools, which limit the risk of poorly executed liquidations to only that specific lending pool. The downside of this is that it could potentially reduce the capital efficiency of lenders versus cross collateralized counterparts, and that a pool must exist or be created for the pair (of collateral tokens to lending tokens). By using this method, the SushiSwap team believes that making isolated pools easy to create and finding other ways to supplement yield, such as flash loans or BentoBox, are viable and potentially less risky solutions to offer more assets and pairs as both lending assets and borrowing collateral.

Additionally, using isolated lending pools in conjunction with flash loans, these pools can be used to created an on-chain leveraged short, as described in the SushiSwap documentation here:

Lastly, Kashi aims to be more efficient than its competitors to provide better user experience and cheaper transaction costs. Kashi’s contracts are optimized for minimal gas usage again through using isolated lending pools. Typically on Ethereum, the gas price for performing a transaction is more expensive when contracts require higher amounts of computation. This means that  sending an erc-20 token would be much cheaper than deploying a contract to the Ethereum mainnet or interacting with deployed contracts. Due to the pools being isolated, the computation requirements are much lower than having multiple assets supplied and borrowed in a pool. The protocol also employs elastic interest rates to maintain a high utilization ratio of funds being supplied, which keeps yield in an ideal range. If utilization of assets goes to 100% or all assets are being lent out, users will not be able to withdraw capital until the utilization ratio decreases. The ratio can decrease when more lenders enter the market or creditors replay loans, which is why it is so important to keep utilization high but never at max capacity. By having a system in place to adjust incentives dynamically according to over- or under-utilization of the pools, a healthy balance can be found between maximum yield from borrowers and buffer of max utilization if the rates are too low. 

Minimal Initial SushiSwap Offering (MISO) is the Sushi team’s spin on an Initial DEX Offering (IDO) platform to help teams launch tokens and fundraise in a decentralized fashion. Currently the Miso launch pad is a set of curated projects, however the goal is to make the platform permissionless in the future where projects will be able to launch and crowdsource capital without any required interaction with the core Sushi team. 

The idea behind MISO was to provide a direct route for projects to launch a token and drive more pairs and liquidity to the SushiSwap ecosystem itself. By providing a platform to achieve this, it is beneficial to the entire suite of products that Sushi offers and creates a whole ecosystem for the lifecycle of a token. The MISO platform itself also provides a set of open-source contracts called the ‘Ingredients’ that teams can use to provide a well-executed IDO in a safe, tested manner. The tools that are offered are split into the categories below:

SushiSwap Documentation

The Sushi team organizes these ‘ingredient’ contracts into bundled smart contract structures called ‘Recipes’. Teams can then choose to deploy a variety of preconstructed ‘recipes’ that fit their needs, knowing that the contracts are battle tested and will provide seamless integration with the rest of the SushiSwap ecosystem.

Trident is the Sushi team's take on a next generation AMM focused on capital efficiency and composability between other Sushi offerings. This product is currently under development and is one of the core focuses of the team currently. Previous to the announcement of Trident, it was believed that a proposal named Mirin would be deployed, allowing centralized exchanges to host staking of SUSHI to earn yield from the protocol to introduce more users to the benefits of DeFi. This yield was achieved through AMM fees earned on the traditional SushiSwap V2 AMM and the touted V3 AMM that would increase capital efficiency through concentrated liquidity pooling. However, this proposal was scrapped in favor of the newly announced Trident offering, which was developed in secrecy.

The protocol is structured in three prongs/categories that set it apart from traditional V2 and V3 AMMs. Trident takes a unique approach to the AMM by understanding that different trading pairs each have ideal liquidity pool structures to maximize efficiency. 

The first prong of the Trident protocol is the LP structures. 

Four different LP structures are used within the protocol:

The second prong of Trident is building on top of the BentoBox vault, which allows for improved capital efficiency and breaks down the issue of segmented liquidity amongst different protocols such as AMMs, lending, and synthetics, even if they were on the same Layer 1. Additionally, token approvals only needing to be done once saves users fees and can potentially reduce slippage when combined with the optimal pooling type for each pair. 

The third prong of Trident is the Tines Routing Engine, which will increase the efficiency of swaps and reduce slippage and price impact across the board. Traditionally, if one wanted to go from currency X to Z, it would have to be routed as follows:

Trade X -> Y then, Trade Y -> Z

Currently this is a viable solution but is not efficient. The user has to perform multiple swaps and approvals, and the hops can cause large price impacts if the spreads are not tight or the pairs are thin due to notional size being swapped between pairs X/Y and Y/Z. 

Tines Routing Engine helps to reduce the impact on these pairs by finding other routes and a combination of pools to act as one to perform the trade. This helps by breaking up the notional size and finding the best pools that are optimized for each route, i.e. concentrated pools if doing a stable swap in between. Usually this would be much less cost effective, but because Trident is deployed on top of BentoBox, all of the approvals are only required once for each asset and all the contracts are meant to be optimized to save gas, making this both the cost- and execution-efficient solution the Sushi team was looking for. Trident is set to release in the near future.

Pool Types (from Trident Documentation)

Constant Product pool

In this pool type, swaps function automatically thanks to the formula: x*y=k, also known as the constant product formula

Hybrid Pool

Hybrid pools were included to allow users to swap like-kind assets at reduced price impacts. In hybrid pools, users can include up to 32 assets in just one pool. Based on the idea of what a stable swap curve would look like, this allows for similar assets to be traded amongst one another in a single pool with less interference from other market factors or clearly dissimilar tokens.

Concentrated Liquidity Pool

As shown in the picture, liquidity providers will be able to select the token price range in which they wish to receive platform fees. This is in the hopes that the amount of the pool that you need to share with fellow providers will spread more evenly between several ranges, offering you a bigger piece of the pie in your selected range, which means higher fee accumulation. For concentrated liquidity pools, the ultimate benefit is that it will allow liquidity providers to more narrowly scope their liquidity provisioning to maximize share of revenue they receive from platform swap fees across Sushi.

-Sentiment & Tweet Volume

We can see a decent correlation forming between the tweet volume around Sushi and then sentiment of the project. The Trident protocol was announced in late July of 2021 and we can see a direct impact on both tweet volume and over all sentiment which we can assume in large part is due to this announcement as well as a series of other significant events such as cross chain integrations to other Layer 1 chains.

Significant Developments

Using The TIE’s proprietary SigDev feed, we can take a look at some of the most notable events for the SushiSwap team over the past few months. Along with the announcements of the next gen AMM Trident and NFT marketplace, Shoyu, the team has been working hard to integrate and form partnerships with other Layer 1 solutions. 

In the past few months, Sushi has announced integration with Harmony (ONE) and Avalanche, as well as other joint DeFi initiatives to help propel the space to new heights. 

AMM Comparison

While Sushi’s AMM isn't the only flagship product anymore, it still holds its ground against the other major AMMs, such as Uniswap v2, Uniswap v3, and PancakeSwap. SushiSwap currently holds roughly 8.6% of the market share based on daily volume. However, this listing of SushiSwap is only recording ETH Volume. Accounting for Sushi’s major presence of other chains as discussed, if those non-ETH volumes were aggregated, Sushi would be sitting closer to ~10%, placing it just behind PancakeSwap. 

Sushi has come a long way since its early days and overcome many obstacles stemming from both an innovation standpoint as well as early internal struggles with an anonymous founder. A difficult road ahead, the team set out to make Sushi its own unique offering and shed the narrative of being nothing more than an Uniswap clone. A little over a year old at the time of writing, Sushi has set itself apart with astounding numbers and offerings in a space that moves at breakneck speed. The main AMM product current is supported on 14 different chains making it one of the largest cross chain liquidity protocols with just over $1.4B of liquidity provided and $108B of volume transacted since inception. Looking forward, the boundaries continue to be pushed, as  the Shoyu NFT market place is under development and the Trident AMM protocol is set to release later this year, supporters of SUSHI continue to have high hopes moving forward.

This report is for informational purposes only and is not investment or trading advice. The views and opinions expressed in this report are exclusively those of the author, and do not necessarily reflect the views or positions of The TIE Inc. The Author may be holding the cryptocurrencies or using the strategies mentioned in this report. You are fully responsible for any decisions you make; the TIE Inc. is not liable for any loss or damage caused by reliance on information provided. For investment advice, please consult a registered investment advisor.