How to get bots to stabilize your protocol
Many defi protocols, e.g., stablecoins, rely on bots for their health.
The focus is often on “searchers”, but two other groups, market makers and solvers, also stabilise protocols.
This article outlines which actor serves which protocol best and how you can ensure they are there to stabilize your protocol.
Protocols that need help
These protocols typically need help from bots to function:
- DEXs: A DEX with the wrong price is unreliable for traders and dangerous for LPs. Arbitrageurs align DEX prices with the market.
- Lending Protocols: Bad debt sinks a lending protocol (and its lenders). Liquidators protect a lending protocol from bad debt.
- Stablecoins & RWA tokens: A stable peg creates trust and drives usage. Mint & redeem arbitrage maintains the peg.
- Liquid staking derivatives (LSDs): Deep books create trust in an LSD. Deposit and withdraw arbitrage prices in line with their intrinsic value.
- Treasury Rebalancing: Many protocols accrue fees in a variety of tokens. Searchers rebalance those tokens to the preferred treasure asset (e.g., ETH).
Other examples include perp protocols relying on funding rate arbitrage, yield aggregators that need rebalancing, and bridge protocols that rely on arbitrage to the canonical bridge.
But, who are these arbitrageurs, what motivates them, and how do they differ in skills and effect on your protocol?
What Searchers, Solvers and Market Makers want
Three groups respond to incentives and can stabilize your protocol: Searchers, Solvers and MarketMakers.
Each trades under different conditions and responds differently to your incentives:
Searchers look for atomically profitable opportunities – often referred to as "triangular arbitrage". They sell the asset they buy from you elsewhere on-chain in the same transaction. For a searcher to help you, there has to be at least one other venue on the same chain to trade the tokens – and enough profit to pay for gas.
Solvers look for the best available price on-chain for a user's trade. They require user trades that matches your tokens to trade on your protocol, and you need to offer a better price than any other protocol on the same chain.
Market Makers trade with their inventory. They buy low and sell high on different venues (e.g. ETH L1 and Binance) at the same time. The surplus from this arbitrage needs to cover gas, opportunity, and inventory costs.
However a profitable trade or the best price along might not be enough.
Circumstances that can break your incentives
Under different circumstances, same incentives will lead to a different response from the same teams:
- Available liquidity: If there is no liquidity on-chain that’s atomically accessible (within one tx) to bots, then searchers can’t trade. If you rely on searchers, deep liquidity outside your protocol must exist on the same chain at all times.
- Competition for liquidity: Understand who else competes for the same liquidity. If a collateral asset crashes, other protocols will compete for access to the same liquidity to liquidate, and it needs to support their plus your exposure.
- Competition on gas: There’s only so much space in a block. If other trades crowd out your tx, then none might be able to land a transaction on your protocol for a few blocks – especially if that tx is gas-intensive.
- Available Inventory and Trades: Market makers have limited inventory, and it takes time to replenish. In a flash crash, market makers might use up their inventory and not have enough to continue trading on your protocol despite it being profitable.
- Available trades: Solvers will buy from you if you have the best price, but only if they have matching user orders – so when no-one trades your token through routers or intent auctions – solvers won’t be able to stabilize you. (*it also works if your token is connected to two tokens that each have high demand).
- Volatility changes cost of capital: Market makers might be willing to hold an asset in some market conditions but not others – so consider what effect volatility will have on their behaviour under the conditions where you need them most.
So, the response to your incentives depends not only on who acts on the incentive – but also on the circumstances in the market.
This also means that, depending on your protocol and when you need help, you should focus on different actors.
Who to rely on for what purpose
From the above preferences of each group and circumstances that can affect them, we can draw a few conclusions:
- For rapid response, use searchers: Searchers are most experienced with dynamic bribes (especially useful in volatile and congested markets) and can act instantly and without volume limit – as long as there is liquidity somewhere on-chain. They are, however, also the most expensive (your incentive needs to cover price impact, exchange fee, and gas for at least two trade legs (buy and sell).)
- For tight pegs on assets that move slowly and cheap rebalancing, rely on solvers: Solvers will trade as long as your price is marginally better than the next venue (so you don’t need to offer them “profit”). Therefore, they can act on less incentive, are cheaper, and provide tighter pegs. If you can afford to wait and there is frequent trade volume through your token – solvers are the best option.
- If there’s little liquidity on-chain, rely on market makers: Market makers have inventory and access other venues (other chains or centralized exchanges). If you rely on liquidity that’s not on the same chain or not atomically accessible (e.g., if you have a withdrawal delay) – then you need to rely on market makers. Market makers are also usually cheaper than searchers (as they only trade one leg on-chain).
- Don’t combine fast action and non-atomic liquidity: Since market makers can always run out of inventory and therefore can’t guarantee instant action, especially when you might need them most, do not build mechanisms that need fast action (like liquidations) over tokens for which there is no atomic liquidity on-chain.
- Atomic composability: Atomic composability, and permissionless access greatly increase the number of actors who can trade on your protocol (from only market makers to also all solvers and searchers). Also, consider exposing an interface with the functions that routing algorithms need.
These are the main gotchas to keep in mind.
However, none of this matters if no bot integrated your protocol.
Don’t expect arbitrageurs to just show up
No matter how much volume or TVL, how good your docs, how large your community, or how attractive your incentives – don’t rely on bots to just show up.
I've seen protocols with billions in TVL, months of building a community, and millions in arbitrage incentives still not have a single searcher searching on their protocol.
Arbitragers are both more busy and less flexible than you’d assume. Any quirk in your protocol, or even wrongly assuming that other searchers are already after this opportunity, can stop a team from pursuing it.
You simply should never trust that enough teams have a working implementation for all your protocol states and under the different circumstances where you need them.
To ensure stability, take direct action, and verify that those actors are watching your protocol.
How to make sure that arbitrageurs trade on your protocol
Integrate yourself: Instead of convincing teams to integrate you – integrate yourself.
Tycho Protocol Integration connects you to all actors: Solvers (& routers), searchers, and market makers. And it’s a process you control and can take care of before launch.
Reach out to us (@tanay_j on tg), we can guide your team during the integration or find someone to do it for you with a bounty.
Verify integrations: Get in touch with searchers, solvers and market makers. Either through us or directly in our builders tg group: tycho.build – to verify that your integration works as expected.
Build your own: Many teams now build their own bots, at least as a backup you can rely on. Tycho makes it easy to build a custom bot that can trade on your protocol and access all on-chain liquidity (to close the arbitrage loop).
Reach out to us (@tanay_j) we can help find a team.
Conclusion
Solver, searchers, and market makers contribute differently to your protocol, and you’ll likely need a combination of them.
Tycho reaches them all. Integrate yourself today.
