🍣 The Sushi Saga and the Future of DeFi — Issue No. 108

This week has been one of the wildest in crypto, and that really is saying something. I'm talking about SushiSwap— a fork of the Uniswap decentralized exchange— and the incredible drama around it's creation and launch.

If you haven't yet caught up on this story, you might want to take a deep breath. It's a doozy. And aside from being a riveting tale, it also has wide ranging impacts for the future of the Decentralized Finance movement. In this issue, I'll give some background on Uniswap, explain what happened with SushiSwap, and end by exploring the implications for the ecosystem.

Uniswap

Uniswap is a decentralized exchange (DEX) built with smart contracts on Ethereum. It allows traders to swap between pairs of tokens that exist on the network. Unlike most exchanges, Uniswap does not use a so-called "order book" model. There is no list of buyers and sellers who declare the price at which they're willing to exchange. Instead, Uniswap uses Automated Market Makers, or AMM, to establish the price.

For any pair of tokens which trade on Uniswap, there are two liquidity pools. Anyone can deposit their funds to the pools, and the ratio between the pools determines the price. If the ratio (and thus the price) is "wrong," it creates an arbitrage opportunity which can be exploited by traders, bringing the system quickly back to the market price. Liquidity providers earn fees of 0.3% for putting their capital into the pools.

The first version of Uniswap was built as a side project and bootstrapped further with grant funding. The project's creator, Hayden Adams, has published an extensive history of how Uniswap came to be, which is an interesting read. Link.

Uniswap was not the first to implement the AMM model for a DEX, but they were the first to do it in a simple and autonomous way. In fact, Uniswap has long been the model of doing DeFi the "right way." The design of Uniswap is simple, eschewing the complexity of a needless token. Unlike many DeFi projects, which launch with admin keys that give their creators broad powers, Uniswap was autonomous from day one. It modeled the "Unstoppable Code" moniker more than any project in the space, and was rewarded by quickly becoming the most popular DEX.

Uniswap V2

Earlier this year, an upgraded version of Uniswap was released. When the Uniswap team developed and released version 2, it had to compete with the existing version like any other product would. Users and liquidity migrated because the new version, which is also autonomous and unstoppable, had features and functionality that they wanted. Again, no token was included in the upgraded version.

Uniswap V2 did make one move toward sustainability: the contracts include a mechanism which allows the developers to direct 0.05% of fees toward the development team, with the remaining 0.25% fees going to the liquidity providers. By default, the developer fee is turned off, meaning liquidity providers continue to earn 0.3%. The smart contracts are coded such that the mechanism can simply be switched on or off. The percentage going to the dev fund cannot otherwise be adjusted, nor can any other changes to the protocol be made.

In early August, the Uniswap team announced they'd raised $11 million in Series A venture capital funding led by the high profile firm Andreessen Horowitz. This set in motion an incredible series of events.

A Vampire Sushi Chef

In late August, a pseudonymous developer going by "Chef Nomi" announced "SushiSwap," a clone of Uniswap with "Sushi Tokenomics." Link.

The developer took Uniswap's open source codebase and hacked in a new token that could be "farmed" by liquidity providers. This means that in addition to getting fees from traders, liquidity providers also get Sushi tokens, which can then be used for governance to modify certain aspects of the system. The new system was framed as being "community controlled," and Chef Nomi sought to paint Uniswap's founders as somehow selling out by taking venture capital funds.

The SushiSwap creators did more than just use Uniswap's code to launch their own version. They went a step further by actually using Uniswap for their launch. Before SushiSwap was even launched as an exchange, it was possible to earn Sushi tokens by providing liquidity to Uniswap. This mechanism was coded in such a way that the liquidity could then be migrated over to SushiSwap when it launched. The technical details of this so-called "vampire attack" are too arcane to delve into, but suffice it to say the system leveraged Uniswap to bootstrap it's own liquidity while ultimately draining that liquidity away.

Capitalizing on the current "yield farming" craze, the Sushi token took off. Liquidity poured into Uniswap to farm it leading up to the launch, and the value of the token itself shot up. This is where things really start to get weird.

Pump and Dump and Pump

The SushiSwap system directed 10% of all tokens to a wallet controlled by the pseudonymous "Chef Nomi." This was dubbed as a development treasury, one that would supposedly be used to fund continued work on the project. On September 5th, before the migration to the SushiSwap exchange had even taken place, the founder sold all of their shares, netting them 38,000 ETH, valued at $13 million. Ironically, the transaction took place on Uniswap. The burgeoning community around SushiSwap was shocked, and the price of the token tanked.

Despite this, a number of people who had farmed Sushi tokens began coordinating to save the project. They argued that while Chef Nomi had sold their share, the contracts were still autonomous and "community controlled," and that Sushi could be salvaged. The treasury was transferred to a multi-sig contract controlled by a number of these community members, and they pushed to move forward with the migration of Uniswap's liquidity. Meanwhile, Chef Nomi continued to make cryptic comments about somehow remaining a part of the project despite selling off the dev funds. On Twitter, rumors about who the Chef was began to circulate, as did threats of legal action.

Now, if you're thinking to yourself, "wow, that's a wild story," you better strap in, because it get's even crazier from here. On September 9th, the community members trying to salvage Sushi moved forward with the migration, draining 75% of Uniswap's liquidity into the newly launched SushiSwap exchange. Two days later, Chef Nomi sent the 38,000 ETH they had netted to the new multi-sig treasury, saying on Twitter, "To everyone. I f-cked up. And I am sorry." Link.

So...What Now?

As it stands now, the SushiSwap exchange is live, and has much more value held as liquidity, though its trading volume remains about half of Uniswap's, and it offers far fewer token pairs for trading. The Sushi token price has recovered some of its losses. Will SushiSwap eventually surpass Uniswap to become Ethereum's dominant DEX? Will users and liquidity migrate back to Uniswap once the rush to farm Sushi tokens dies down? Or will liquidity somehow remain fractured between these two DEX's for the foreseeable future?

Whatever happens, there's no doubt this saga will have a deep impact on the future of DeFi. If SushiSwap ends up winning out, we won't see a project launch in this space again without a governance token involved. That sounds like a hyperbole, but I really think it's true. There is enormous pressure as it is for builders in this space to bolt a token onto any project that could possibly have one. Those pressures have increased in the last few months with the rise of yield farming.

If a clone project, with a token of questionable utility, launched by a shady pseudonymous figure who did two weeks worth of work, ends up surpassing a project that had hitherto been the model of doing DeFi the "right way," then we can forget about builders doing things the "right way" from here on out. The incentives for devs are already too far out of whack as it is. Even if Sushi ultimately fails, the damage may already have been done.

Governance Gimmicks

Governance tokens aren't always bad. There are some systems that can't exist without regular human intervention, and all things being equal, adding a well designed governance token to such a system can beat a more centralized alternative. But if something can exist autonomously without governance— as Uniswap clearly has for two years now— then adding a governance token in makes the system weaker, not stronger.

My guess is that, from here on out, developers who have an idea for a project that doesn't require a token will either shove one in anyway, or simply find something else to work on. Why toil for years on something if you risk being surpassed by a tweaked version of your own code redeployed by developers who are just looking to make a quick buck?

In fact, the Uniswap developers themselves will likely launch a new version with a token at some point. It'll be hard to fault them if they do, and knowing the team, I'm sure it will be well thought out and carefully implemented. Still, I can't help but feel disappointed, seeing a project that didn't really need a token being pressured to put one in to remain relevant. Many of these tokens feel more like viral marketing gimmicks than useful innovations. They benefit early accumulators, but make the experience worse for regular users in the long term.

Another possibility is that we'll see new DeFi projects move away from open source licensing. Smart contracts, which need to be auditable to be trusted, might be distributed under restrictive "source available" licenses that prevent others from actually using them. Of course, someone could still try to do so pseudonymously, but the legal cloud that would hang over such a project might at least help discourage adoption from reputable parties. Front end user interfaces will simply remain closed source.

There is, finally, also the possibility that SushiSwap fails, and the current governance token hype ends up blowing over. Perhaps we're just in a cycle that has to play itself out, and I'm over indexing on the impact of this SushiSwap soap opera. I hope that turns out to be the case, but only time will tell. Crypto remains the wild west. The one thing you can't say about this industry is that it's boring!