PancakeSwap is devouring everyone else's breakfast, surpassing Uniswap in trading volume

This article was published in the decentralized finance community, original title: "PancakeSwap: AMM is Eating Everyone's Breakfast," author: Eva, Mechanism Capital, translation: ChinaDeFi

In the past year, the flagship product of crypto, Automated Market Maker (AMM), Uniswap, has spawned many forks. PancakeSwap initially appeared as one of the many vanilla forks on Binance Smart Chain (BSC) and has recently gained attention due to its rapid growth in trading volume and total value locked (TVL). In the past week, PancakeSwap's average trading volume over 24 hours exceeded $1 billion, surpassing Sushiswap's $2 billion. However, PancakeSwap's growth has faced significant scrutiny, and it is clear that users need to be more cautious when entering the platform. After examining the factors behind its impressive growth, this article will also explore PancakeSwap's surprisingly differentiated product suite, attempting to clarify the future path for this breakfast-themed giant.

We will cover:

1. How BSC fills the market gap
2. Quantifying PancakeSwap's traction
3. Key factors behind PancakeSwap's success
4. Major challenges faced by AMM
5. [Bonus] Returns to token holders

How BSC Fills the Market Gap

Ethereum's congestion and expensive gas fees have made it inaccessible for ordinary market participants, leaving a significant gap that needed to be filled. BSC has quickly and successfully addressed this market demand by offering gas fees over 1000 times cheaper and block times faster than 10 seconds. This advantage stems from the fact that BSC sacrifices decentralization for throughput: Ethereum relies on an open and decentralized miner community to solve complex algorithms (PoW), while BSC uses a closed and permissioned validator system (permissioned Proof-of-Staked-Authority). While there is no doubt that BSC is more centralized than Ethereum, the explosive growth in BSC usage proves that, at least in terms of adoption, centralized trading is valuable.

Specifically, BSC also fills the gap between tens of millions of Binance users and DeFi; this is strategically executed through connections made via Binance (one of the largest fiat on/off ramps in the world). In fact, because BSC is more decentralized than Binance, it serves as an upgrade to centralized exchanges, as trading functions are now more transparent and auditable on-chain. Additionally, Binance is the world's largest crypto custodian, which also benefits BSC immensely. This means they can package a vast array of trading assets listed on Binance.com and allow users to withdraw to BSC. This feature allows tens of billions of dollars worth of tokens to be inserted into DeFi applications on BSC, increasing the utility of BSC applications and the inserted tokens. As more utility and assets are added on-chain, the network effects of BSC also increase. Fewer users will need to transfer their assets to other chains or exchanges.

Despite not being fully decentralized, BSC still offers many classic advantages of public blockchains. Public blockchains like Ethereum create a permissionless, composable, and censorship-resistant environment. While BSC cannot guarantee censorship resistance, it retains more of the permissionless characteristics and composability of more decentralized blockchains, which still allows innovation to thrive. Similarly, the core of this debate is a trade-off: extremely high gas fees or centralization and its inherent trust assumptions. In many ways, the development of BSC and PancakeSwap reinforces a well-known fact in the industry: most people (especially retail) will not decentralize without a compelling reason. Particularly with the repeated delays of Ethereum's scaling solutions, BSC provides individuals a way to participate in many of DeFi's best features in other ways.

Quantifying PancakeSwap's Traction

From a distance, PancakeSwap seems to have achieved significant growth. However, it is only through a close examination of the data that we can see how impressive PancakeSwap's appeal truly is.

For AMM, TVL is a direct representation of liquidity. Higher liquidity can serve larger trading volumes, thereby attracting more liquidity. The following chart shows how PancakeSwap's liquidity has significantly increased compared to Sushiswap and Uniswap. However, as DeFi attracts more users, the total TVL of all AMMs is also increasing. The difference is that the growth of BSC's TVL tends to attract new retail participants, whose behavior is markedly different from Ethereum-based users. In terms of trading volume, PancakeSwap's 24-hour trading volume continues to compete with Uniswap, with its daily trading volume exceeding Uniswap's in the past week.

On-chain data shows that PancakeSwap's daily user count has been increasing, even surpassing Uniswap's daily user count. This is because PancakeSwap targets both retail users who have been priced out by Ethereum and DeFi users who want to trade/invest/arbitrage with lower fees. Similarly, the ratio of daily trading volume to user count is also relatively lower than that of Ethereum-based AMMs. This supports the observation that BSC users tend to be smaller retail participants on average. Our previous research summarized in this article debunks the common accusation that PancakeSwap's numbers are primarily due to fake activity or bots. Instead, it points to an emerging retail base.

Data on the trading sizes across all trading pools also indicates a higher prevalence of retail investors. The following chart shows that most BSC trades are under $10,000. In all these pools, trades under $1 outnumber those over $50,000.

Moreover, the retention rate of new PancakeSwap users indicates that the quality of new users has improved since February. The number of new users per day and the total user count are both increasing, but the gap between new users and total users is also widening, indicating that more new users are converting into regular users. This suggests that retention/user stickiness has improved, and the activity peaks are not just short-term anomalies. Considering PancakeSwap's high yields, customer stickiness, and high trading volume, these are the most important factors proving its high CAKE inflation costs (discussed further below).

To supplement this data, we also surveyed the community and found that its traction and engagement are very real. This attention comes from a new user base whose ideology and experience are not as developed as Ethereum participants. To add color, the #Pancakeswap hashtag has accumulated over 1.8 million views on TikTok, with 15,000 videos from 541 different YouTube channels. Interestingly, we also observed that communities in Asia (especially the Philippines and Thailand), South America (Brazil, Argentina, Venezuela), and North America are solely using BSC and PancakeSwap.

Source: Brand24, 3 months (Jan - Mar)

Key Factors Behind PancakeSwap's Success

Clearly, PancakeSwap's appeal is real and undeniable. But how did this initially simple breakfast-themed fork achieve such tremendous success? Why has it been so successful?

a) PancakeSwap leverages an aggressive token issuance plan to drive its growth and fend off competitors.

PancakeSwap's native token, CAKE, follows an infinite minting and burning token mechanism; it is an inflationary token without a hard cap limit, but if the burn rate exceeds the issuance rate, it becomes deflationary (similar to the EIP-1559 approach, which relies on economic growth to offset protocol inflation). This design allows the platform to stimulate significant liquidity, which has proven vital for the health of AMMs.

Initially, triple-digit annual percentage yields (APY) lured liquidity providers (LPs) to guide supply. These rewards ultimately increased TVL and initiated a reflexive flywheel, where token price appreciation led to higher APYs and more TVL. Once the platform accumulated deep liquidity across various tokens, it quickly became the dominant decentralized exchange on BSC.

PancakeSwap's aggressive inflation strategy is one of the key factors driving its TVL increase. Other existing first-layer AMMs will find it challenging to compete on BSC unless they start minting tokens specifically for BSC rewards, and even then, it may trigger an unsustainable incentive war. For example, no rewards were allocated for Sushiswap's BSC issuance, making the liquidity of the rapidly growing Ethereum DEX pale in comparison to PancakeSwap. Additionally, PancakeSwap hosted reverse Syrup Pools, encouraging Ethereum-based Sushiswap users to convert their ERC-20 SUSHI tokens into BEP-20 tokens and earn CAKE. Similarly, PancakeSwap also hosted farms to attract SUSHI-ETH LPs to migrate to BSC, gaining higher yields while lowering trading fees (initially, these annual rates reached up to 160%, and since then, approximately 60% has settled in the pool with a TVL of 14M). PancakeSwap positions itself as the leading AMM bridging liquidity for Ethereum on BSC, further strengthening its role in the ecosystem by maintaining optimal liquidity for BEP-20 token pairs.

Despite this momentum, it is worth noting that the aggressive inflation plan is just one of many driving factors behind PancakeSwap's success. There are many other aggressive inflation AMMs that have not achieved the same level of success.

b) PancakeSwap is more than just an AMM; it is building a complete product stack to facilitate the growth of PancakeSwap's core products.

Some view the project as a lack of innovation Ethereum template, overlooking the important ways PancakeSwap has gone beyond its Uniswap fork. Specifically, the project has attracted a unique community, expanded its product suite, and built synergistic DeFi primitives on top of its AMM.

Their token issuance mechanism, known as Initial Farm Offerings (IFO), is a major example of a fundraising design related to PancakeSwap's core AMM primitives. The IFO process allows users to participate in the "pre-sale" of new projects using their CAKE-BNB LP tokens. This benefits PancakeSwap as users must provide liquidity to participate. Similarly, new projects can use the launchpad to raise funds and directly launch their initial liquidity. This also benefits CAKE holders, as all CAKE from LP tokens (half of the raised funds) will be burned as a deflationary mechanism. Additionally, the increasing order volume for IFO projects indicates that demand for IFO projects and the market value launched through PancakeSwap is rising.

In addition to traditional mining (LP tokens used for rewards), the platform has also introduced Syrup Pools, allowing CAKE to earn more CAKE/other tokens. This has increased community project collaboration and enthusiasm for launching Syrup Pools, as they can leverage PancakeSwap's superior coverage and market attention. Furthermore, the single-sided APY staking of CAKE not only reduces market supply but also dilutes non-stakers. This immediately forces the "use" of the token, as stakers feel they gain immediate value from staking, while those who do not stake are penalized. These Syrup Pools have accumulated over $2 billion in TVL across 50 pools, accounting for about 30% of the total TVL. The second effect is that it has even spawned active yield aggregators like Pancake Bunny and AutoFarm, which rely to some extent on CAKE issuance and compounding to formulate yield strategies.

Meanwhile, PancakeSwap continues to build a vibrant community around its products through gamified features like NFTs and lotteries. In terms of NFTs, users are encouraged to purchase them to create a profile, allowing them to participate in IFOs and other activities. They also earn collectible NFT rewards for participating in different IFOs and competitions. As of April 16, 2021, over 123,211 NFT profiles have been created, with each profile costing 1.5 CAKE (approximately $24). As for lotteries, they run four times a day, with each ticket costing one CAKE. The total number of unique addresses participating in the past month was 38,419. At the same time, the two-week retention rate for lottery participants is around 10%, which is close to the platform's overall retention rate. However, when it comes to trading behavior, lottery participants have a higher retention rate (around 40%) and are more active in all PancakeSwap activities. This is key evidence that PancakeSwap is seeing real retail participation, as participating in these NFTs or lotteries is not profitable for traders and arbitrageurs.

Another gamified example is the recent social trading competition, where teams compete to win CAKE, NFT collectibles, and other gamified achievements. This initiative attracted over 53,000 users, all of whom built profiles by burning CAKE, purchasing NFTs, and registering a team to participate. The use of team-themed Instagram filters and other discussions in team-specific Telegram channels illustrates how it attracts retail participants.

These supplementary products have elevated PancakeSwap's attention and engagement to levels beyond what Uniswap and Sushiswap have seen. This community appeal may further enhance as they build out other roadmap features such as: gamified rewards, lending, margin trading, binary options, fixed-term staking, and referrals.

Major Challenges Faced by PancakeSwap: Unsustainable Issuance

PancakeSwap has risen rapidly, but it will still face challenges in the coming weeks or months. While issuance is at the core of PancakeSwap's success, these issuances are also akin to dilutive equity financing; this is similar to how companies use cash on their balance sheets to pay for user acquisition (referral bonuses, new user subsidies, etc.). Whether in traditional or DeFi schemes, incentives need to be targeted and strategic to reward behaviors that generate long-term value and network effects. In PancakeSwap's case, the adoption achieved through yields and other incentives must exceed the costs of dilution.

Currently, 8.064 million CAKE tokens are minted weekly, most of which are immediately burned in the "burn pool"; this can limit the amount of CAKE entering the circulating supply. To combat the effects of this inflation, the platform has integrated some deflationary measures to burn CAKE and balance total issuance (see Appendix A for the burn breakdown). Overtime, CAKE rewards entering the circulating supply have decreased from 7 million weekly to about 4 million.

So, what’s next? How will PancakeSwap manage their inflation and liquidity mining (LM) expenditures?

We have identified several methods:

1. Purely relying on deflationary pressure to ensure burns exceed supply
2. Establishing a long-term LM budget, allocating a percentage of total supply and limiting issuance
3. Minting CAKE for each program
4. Establishing monthly/quarterly sales budgets and minting supplies

The first method is PancakeSwap's current configuration, but its deflationary pressure has negligible effects on supply inflation. The second (also the most traditional) method may not adapt well to the fast-moving nature of the space, potentially leading to oversupply/undersupply of allocations. The third method is the most flexible/adaptable but may encounter bottlenecks or difficulties in effectively coordinating decentralized governance. The fourth method is a reasonable middle ground.

More specifically, combining monthly/quarterly LM budgets with more effective deflationary pressure may be a better way forward. Specifically, it is difficult to know how much inflation will be needed in the future, but the team and core community members should have a profound understanding of how to plan in the near term. In fact, this unpredictability explains why some projects (e.g., Yearn, Synthetix) need to redesign their issuance schedules and mint more tokens; their treasury does not have enough funds to support protocol development and other incentive programs. If uncertainty is the only certainty, protocols should generally formulate flexible monetary policies around this rather than arbitrarily locking themselves into strict issuance schedules.

The PancakeSwap team and community can propose monthly or quarterly LM issuance budgets, passing this budget through governance or an elected council. By doing so, they can reduce the spending of token holders on extravagant liquidity while further stimulating more useful liquidity. Regarding the topic of token holder value, we also include some bonus analyses in the appendix, analyzing PancakeSwap's fully diluted price-to-earnings ratio compared to other AMMs.

Conclusion

While PancakeSwap's growth is impressive, it ultimately owes its success to BSC, which depends on the trade-off management between throughput and decentralization. However, BSC's undeniable growth highlights that centralized products are more readily adopted by retail compared to their decentralized counterparts. As more people engage with blockchain technology, the ideological divide among every marginal builder and user will diminish. Developers will choose to optimize different factors at different points in time, whether it be network scalability or security achieved through decentralization. Currently, PancakeSwap has many retail users and attention, but this may shift into data storage scale issues, as Ethereum has encountered scaling problems, accompanied by delays in EIP1559 and potential liquidity fragmentation, all of which will show in the adoption on Layer 2.

In the short term, PancakeSwap's success is both dependent on BSC's success and symbiotic with it; as PancakeSwap's appeal to BSC grows, the ecosystem begins to create network effects for PancakeSwap. But what does the future hold for PancakeSwap? Will Binance be forced to shut down, taking BSC down with it? Will PancakeSwap stand against its critics and establish itself as a respected AMM? More importantly, can BSC continue to coexist with Ethereum and occupy a completely different niche?

Of course, it is impossible to know the answers to these questions. However, it is clear that PancakeSwap has transcended a simple fork and has a path to broader community acceptance. Sushiswap was initially a vampire fork, and it has shown that projects that grow through product differentiation and innovation have a place. PancakeSwap has already expanded and will continue to expand its product suite to target entirely new participants, many of whom have never used Ethereum before. Ultimately, those projects that attract more users to this space should be praised for what they build and how they optimize to meet market gaps. In the short term, the broader community needs to recognize the value PancakeSwap brings to the entire ecosystem, both in terms of innovation and in allowing more people to experience DeFi.

Appendix

A. Main Burning Mechanism

B. Returns to Token Holders

As issuance and the value to token holders are our primary concerns, we conducted a test using the fully diluted price-to-earnings (PE) ratio to see CAKE's current returns to token holders and compared it with Uniswap and Sushiswap. We also simulated a scenario to visualize CAKE's PE value if they followed Sushiswap's issuance schedule and fee structure (30 basis points trading fee, 5 basis points to the treasury).

Using treasury earnings as a representation of future returns to token holders, the chart below shows PancakeSwap's current fully diluted PE value relative to other AMMs.

Note: The current fee structure and returns to CAKE holders are based on a 0.2% trading fee, of which 0.03% goes directly to the treasury. Revenue is not adjusted for inflation.

Considering PancakeSwap's infinite minting, we infer that its current issuance will be fully diluted by the end of 2025. Analysis shows they have been reducing PE and reached Uniswap's ratio in February. Despite trading and treasury fees decreasing by 10 basis points and 2 basis points, PancakeSwap's PE in March still matched Uniswap's. Uniswap's PE growth from January to March is attributed to its token price increase (from $9 to $30), indicating it is generating speculative premiums faster.

Now, let’s simulate a scenario where PancakeSwap's supply cap is around 250 million and follows Sushiswap's fee structure (increasing trading fees by 10 basis points and treasury fees by 2 basis points). For example, the SUSHI token is also designed for infinite inflation but introduced a hard cap of 250 million through governance. The current issuance rate is 30 SUSHI per block, approximately every 13 seconds (Ethereum), which is about 5 times PancakeSwap's issuance schedule (160 every 4 blocks, over approximately 12 seconds).

This analysis indicates that if PancakeSwap sets a supply cap around 250 million instead of 1 billion (expected by 2025), they would have a more favorable fully diluted PE ratio. However, a supply cap should not be arbitrarily set to improve this ratio. While inflation is not directly considered in this model, the flexibility of issuance is likely a key factor in allowing PancakeSwap to build a competitive moat. On the other hand, increasing trading and treasury fees to match Sushiswap's fee structure is an option to increase revenue/returns without changing the product. This can be viewed positively, as it increases returns to token holders while remaining competitive with other AMMs. However, it also takes away revenue from LPs, who are the main drivers of TVL.

Similarly, Uniswap and Sushiswap also have the ability to increase their total supply and issuance plans through governance. It is not uncommon for DeFi projects to change their issuance plans to meet the financing needs of the project (like YFI). Therefore, issuance as part of token economics is just one of many factors contributing to a project's success.