Sino Global Capital

Jun 11, 2021

6 min read

Why we invested in Mercurial Finance

Not financial advice.

Introduction

Stablecoins are an essential component of any decentralized finance (DeFi) ecosystem. The exponential increase of stablecoin holdings from $7Bn in June 2020 to $65Bn in May 2021 is clear evidence of widespread adoption. Stablecoins are the most intuitive assets for retail investors to denominate investments; and are also the dominant fiat on/off ramp medium of exchange. On centralized exchanges, stablecoins are the most common asset that other tokens are paired against. In addition, many investors are drawn into DeFi by the high beta-neutral yields offered by stablecoin farms. These factors have solidified stablecoins’ status as an indispensable part of DeFi.

Growing stablecoin supply. Source: Dune Analytics

Monthly decentralized exchange (DEX) volumes for the USDT/USDC trading pair has increased multifold over the past year — growing from $300MM in June 2020 to a staggering $8Bn in May 2021.

Growing DEX volume. Source: Dune Analytics

Furthermore, the daily transaction count for USDC and DAI have multiplied by a factor of eight since Jan 2020. Clearly, stablecoins are widely used across all areas of DeFi.

Skyrocketing growth of stablecoin transactions. Source: Coinmetrics

Current Problems

The perennial problem that exists is the multitude of different stablecoin variants available (ie. USDT/USDC/DAI). Protocols utilize and implement each stablecoin variant for a myriad of different use-cases, often even issuing their own stablecoin (ie. LUSD on Liquity, alUSD on Alchemix). This fragmentation requires traders to exchange stablecoin variants as each use-case requires. Currently, the main 2 ways to exchange stablecoins on Solana are:

  1. Place order on Serum’s central limit order book (CLOBs) (various DEX interfaces)
  2. Swap on Serum’s Automated Market Maker (AMM) (various DEX interfaces)

However, traders will either encounter issues of low on-chain liquidity within CLOBs, or high slippage incurred from AMMs.

Similarly, another group of stablecoin power-users are lenders who wish to gain some yield on their stablecoin reserves. These lenders have 2 possible options on Solana:

  1. Deposit their stablecoin in a money market to earn interest (not live yet)
  2. Provide liquidity for stablecoin pairs on Serum’s AMM to earn swap fees and liquidity mining rewards if any (various DEX interfaces)

Since these lenders will optimize for the highest lending rate, their supply is highly elastic and will allocate towards the platform offering the highest APR.

Specifically, for AMMs, yields are directly correlated to the trading volume of the stablecoin pair. As explored above, traders will direct their volume towards the AMM offering the deepest liquidity and lowest slippage. Thus, there is a symbiotic relationship between the two parties — traders need the liquidity provided by lenders, and lenders need traders to deliver fees.

With DeFi continuously growing, these lenders must also actively keep up-to-date with new yield farms or strategies in order to maximize their yield. This might not be feasible for passive investors who might not have the time or expertise to execute such strategies efficiently.

Mercurial Finance

Mercurial Finance (https://www.mercurial.finance/) is built on Solana, a highly scalable blockchain that is completely decentralized and permissionless. Solana is the optimal blockchain for Mercurial with its industry-leading 65K transactions per second, 400ms block times, and extremely low gas fees. In addition, Mercurial will be deeply integrated with Serum DEX, tapping into its orderbook flows and liquidity to reduce slippage and boost transactions on both systems.

As the DeFi ecosystem on Solana rapidly expands, the demand for stablecoin minting, swapping and farming will only increase. We will dive into why we think Mercurial Finance is uniquely positioned to capture the lion’s share of this demand — with its winning combination of innovative technology, vision, brand and strategic partners.

The Solution

Mercurial Finance seeks to offer a holistic solution to both parties on the Solana ecosystem. — introducing the concept of dynamic vaults. These dynamic vaults will incorporate 2 important innovations:

1. Amplified Price Curve: Concentrates liquidity around desired range

2. Dynamic Fees: Algorithm adjusts fees according to market volume and volatility

  • High market volatility: Higher fees, reducing IL and capturing higher profits
  • Low market volatility: Lower fees to encourage trading

Benefits for traders

For traders, these innovations effectively solve their aforementioned problems by improving the utilization of the liquidity available, while simultaneously offering traders the benefit of 100x better slippage when swapping stablecoins versus traditional swaps. With both deep liquidity and low slippage, traders will be much more likely to utilize the Mercurial platform as their preferred swapping platform, thus driving the fees earned by liquidity providers.

Capital efficient swaps with dynamic fees. Source: Mercurial Finance

Benefits for lenders

On the other hand, these dynamic vaults attract liquidity from lenders by maximizing the yield for capital invested. This is accomplished via specialized on-chain algorithms which automatically deploy liquidity towards the highest yielding mechanism, including lending platforms, flash loans and external/cross-chain vaults.

Liquidity is further enhanced by allowing users to deposit other tokens (ie SOL/SRM) to mint synthetic stablecoins like mUSD, which can be deposited in the dynamic vaults. These users gain the benefit of retaining exposure to their deposited asset, while earning double yield from:

  1. Interest paid from Dynamic Vaults
  2. Yield from native staking rewards

After depositing their assets, lenders will receive Liquidity Provider (LP) tokens which can be utilized to further boost capital efficiency via:

  • Staking LP tokens for liquidity mining of MER
  • Reinvestment in other Mercurial Vaults
  • Used as collateral on other lending platforms
Key aspects in a Mercurial vault. Source: https://www.mercurial.finance/Mercurial-Lite-Paper-v1.pdf

Seamless UX/UI

Mercurial Finance understands that a highly usable and seamless interface is critical for catalyzing the migration from centralized to decentralized platforms. As such, providing an intuitive interface and comfortable user experience are key priorities to Mercurial. The team is continually working to refine their UX/UI and develop design patterns that will minimize friction.

Clean Mercurial UI

MER Token

The native MER token is designed to have a wide range of mechanism that will accrue value to the token holders:

  1. Fees from usage of swaps
  2. Commissions from returns of the interest and yield accrued by the vault
  3. Collateral for synthetic stables

In addition, the MER token will be intrinsically linked to the governance of the Mercurial ecosystem. MER token holders will be able to vote on key parameters such as swap fees, vault commissions and yield strategies.

Risks & Threats

Competition: There are several stablecoin swap protocols being developed on the Solana ecosystem. Both borrowers and lenders ultimately will choose the platform that offers the greatest benefit to them, be it in terms of functionality, yield, fees or slippage. Mercurial Finance must offer the best solution on all fronts in order to firmly solidify its position as the preferred platform.

Future Opportunities

Integrations with other protocols: As more DeFi building blocks are developed on the Solana ecosystem, we expect that other DeFi applications will take advantage of Mercurial’s smart vaults for a variety of use-cases. For example, a leveraged yield farming protocol can borrow a large amount of a lower-interest stablecoin and utilize Mercurial’s low-slippage swaps to efficiently exchange it for any necessary stablecoin to fulfill a 50–50 ratio. For dapps that mint their own stablecoins, integrating with Mercurial will be essential to maximizing the composability and liquidity of their issued stablecoin.

Beyond stablecoins: Mercurial aims to extend their dynamic vaults to incorporate any token pair. They intend to implement new pricing models to optimize for non 1:1 token sets. This will expand Mercurial’s offering to a much wider total addressable market.

Conclusion

Stablecoins are the bedrock for driving adoption and liquidity in any decentralized ecosystem. We believe Mercurial Finance is an important building block in further enhancing the efficiency of the Solana ecosystem, unlocking even greater value creation and opportunities for investors and traders alike. We look forward to partnering with and supporting the Mercurial team and its community in the future.