DPI/ETH Incentives are ending December 6th - and currently 83% of DPI holders are farming INDEX. With the price increase of DPI, it is currently the 7th largest token in terms of liquidity on Uniswap with $27M.
DPI/ETH liquidity is important in that it allows large purchases and sales of DPI, maintains minimum liquidity for lending protocol integrations (which require liquidity for liquidations), and enables arbitrage opportunities with centralized exchanges that list DPI.
Strategically, maintaining an incentivized DPI/ETH pool allows the Index Coop to retain the current capital (maintaining its meta-governance capabilities and growing its lead as the leading DeFi Index product).
- Minimum Liquidity for Purchases: At a minimum, the minimum DPI/ETH liquidity to be maintained should allow for $100k purchase sizes at 1% slippage. This means ~$10M in DPI that should be locked up.
- Don’t overpay for liquidity: Although the community needs to pay for liquidity, it is not prudent to pay too much. Currently paying 80%+ APY is considered too much for the liquidity. Given its volatility, numerous funds would say that 30%+ APY would be quite compelling to keep their capital in DPI. For comparison, stablecoin APYs are ~20% and given DPI’s volatility, it should be something higher.
- Dynamic Variables are $INDEX, $DPI and liquidity requirements: Given that the $INDEX, $DPI, and $WETH prices change based on fluctuations of the market, these variables must be considered in a sensible incentive program to prevent overpaying.
Inspiration from Bitcoin Difficulty
Bitcoin has solved this problem through their difficulty target and adjustment algorithms, where Bitcoin targets a 10 minute block production given a variable network hash rate. A similar approach can be taken to dynamically tune the rewards required to maintain a certain liquidity target.
Given these assumptions, we can create a dynamic incentives program that achieves the community’s growth and liquidity goals. A few variables can be kept in mind:
- Length of epoch: The length the incentive program runs for with a given $INDEX reward and target liquidity. By no means is the epoch length fixed - it can be changed over time as the community sees fit. Some sensible values include 7 days, 14 days, 30 days, or 60 days. The shorter the epoch, the more frequently $INDEX governance is required. That said, the process can eventually be mechanized and automated into smart contracts.
- Target APY: The target reward rate in APY given to DPI/ETH stakers. Initially, the community may desire to retain 70-80% of the existing DPI farming capital.
- Target Liquidity: The total $DPI in liquidity pools. In addition to the minimum liquidity to transact, there may be strategic reasons for justifying a particular target liquidity (e.g. growth goals, market share capture goals).
- $INDEX Price: To avoid whale / short term price manipulation, a 10 day TWAP price of $INDEX can be used for price calculation. Initially, this will be done off-chain and can eventually be moved on-chain.
Assuming an off-chain architecture, implementation is relatively simple. All that is required is topping up the staking contract account with the required $INDEX each epoch.
Eventually, smart contracts infrastructure can be assembled to automate this process.
Given the structure, the main open questions are: What should the initial epoch length be (time of each voting period) and what should the target APY of DPI be?
- 14 days (More frequent governance required)
- 30 days (Middle-ish ground)
- 60 days (Less dynamic, but less governance overhead)
- $10M (Conservative - Maintain $100k at 1%)
- $20M (Moderate - Maintain $200k at 1%)
- $30M (Growth - Grow and acquire new capital)
- 20% (Minimum - same as stablecoin yields)
- 30% (Moderate)
- 50% (Aggressive)