IIP-53 DPI liquidity Mining - July 2021

[overanalyser]

title: DPI Liquidity Mining - July 2021
status: Proposed
author: @Overanalyser
created: 29th June 2021
discussions-to: IIP-53 DPI liquidity Mining - July 2021

Simple Summary

Continue liquidity mining DPI:ETH for a further 30 days (current staking contract term) with a reduced issuance of 12,758 INDEX over 30 days (a 25% reduction compared to June 2021).

This is expected to result in further migration of on-chain liquidity (and trade volume) to Uniswap v3 and a reduction in the Uniswap v2 pool size.

Abstract

Replenish the current staking contract for DPI:ETH Uniswap v2 LP tokens with 12,758 INDEX so that the current campaign is extended for a further 30 days.

Motivation

IIP-28 in April created a 90 day liquidity mining campaign for DPI targeting a $55 M pool on Uniswap V2. This used the existing staking contract with three 30 day periods and is due to end in ~10th July.

While the $ value of liquidity has dropped to ~$30 M during the recent bear market, this campaign was largely successful in maintaining a market dominating liquidity pool and allowing large trades with minimal price impact.

In May 2021, Uniswap V3 launched on L1 and a DPI:ETH pool has formed which allows more concentrated liquidity. As a consequence, the INDEXcoop research into Uniswap v3 has identified an opportunity to reduce costs on the coop by encouraging liquidity and trading volume to migrate to uniswap v3.

@verto0912

There are several strategies for migrating DPI to V3 and we would like to request community’s feedback on the below options:

1. Turn off incentives completely for the V2 pool and actively communicate our thinking to LPs.

2. Keep V2 incentives for another month, with a 50% reduction, and actively communicate that rewards will cease after this final period.

3. Manually incentivise LPs to migrate through an airdrop.

4. Partner with Harvest and provide some incentives to V3 LPs using Harvest’s vaults.

By making a cut in INDEX rewards, we are expecting LP’s to either migrate to Uni v3, or to withdraw from providing liquidity for DPI. With less liquidity in v2, we expect more trade volume of v3 which should further encourage migration of liquidity.

Please note

There is considerable support within the INDEXcoop community for a complete stop in INDEX rewards for the uni v2 pool at the end of the current campaign and so accelerating the migration to v3:

This proposal for a reduced reward issuance is intended to maintain some liquidity (~$20 M) supported by trade and INDEX rewards for the next 30 days. This is intended to allow time for:

• Uni v7 automated LP strategies to be developed and deployed.
• Further analysis tools and understanding of for uni v3 liquidity to be developed (by the coop and the DeFi community)
• INDEXcoop.com and TokenSets.com buy flows to switch to v3
• 3rd party interfaces to migrate to v3
• 3rd party liquidation bots to include v3 liquidity
• 3rd party lending markets (Cream, Rari, AAVE) to integrate v3 liquidity into their assessments.
• Issue and redemption arbitrage bots to migrate.

Another key consideration is maintaining DPI’s position as the most liquid (in both market depth and total $ value of liquidity) on the market.

---

Please see here for some more discussion around DPI liquidity.

Them main L1 liquidity is located:

27jun21	Unit	Sushi	Uni v2	Uni v3
AUM	Million $	2.89	29.9	2.07
14 day average trade	Million $	0.17	1.61	0.20
14 day average fee	$	432	4,828	594
Annualised average fee income	%	5.5%	5.9%	10.5%
LM incentives (current)	%	12.9%	12.1%	0%
LP rewards	%	18.4%	18.0%	10.5%
DPI in pool	# DPI	6651	69,204	7,620
ETH in pool	ETH	793	8,221	232
DPI in pool	$ M USD	$1.4	$14.8	$1.6
ETH in pool	$ M USD	$1.4	$15.0	$0.4
Sell ETH for 1% price impact	ETH	8	58.5	9.6
Buy ETH for 1% price impact	ETH	8	58.0	11.8
Sell ETH for 2% price impact	ETH	16.3	143.0	25.8
Buy ETH for 2% price impact	ETH	15.9	140.0	24.0

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Specification

Extend the current LM campaign for DPI:ETH Uniswap pair for 30-days using the existing contract for an additional 12,758 INDEX (~425 per day).

No action would be necessary for existing liquidity providers.

FOR

• Extend the mining incentives for the DPI set according to the parameters above.

AGAINST

• Allow the incentives from DPI liquidity to stop at the end of the current campaign (~10 July 2021).

[oneski22]

Any reason in particular 25% reduction vs 50% reduction?

Given the high community support for a complete stop, 25% seems to be a very low reduction.

[verto0912]

To add to David’s question above, I see the reduction of 25% as opening the door for another extension come August. Which would make the overall impact on our liquidity incentives spend even less than 25%.

My preference would be for a 50% reduction with communication around the stop of incentives in August + educational article or 2 on providing V3 liquidity.

[overanalyser]

@oneski22 and @verto0912

The proposal of a smaller reduction than discussed previously (and preferred by the community poll) is based on a number of considerations:

• The v3 pool is currently quite lopsided (see below), the pool has 7% AUM compared to v2, and offers 17% of the $ value for 1% slippage, so it’s only really showing an x2.5 improvement in capital efficiency at this time.
• In addition the v3 pool is doing ~13% of the trade volume of v2.
• Trade volumes have become subdued which makes it harder v3 LPs to be profitable (as IL is increased)
• Managed LP services are being developed, but I don’t think any of them are ready for use with the “INDEXcoop seal of approval”
• Coop Eng resources to update our buy flows / deploy a v3 staking contract etc.
• Wanting to maintain our dominance of liquidity in the sector.

---

I know DPI liquidity rewards is a large expense for the coop, and I want to take them to zero. However, I’m proposing a slower ramp down.

[verto0912]

Thanks @overanalyser. As currently structured, I will be voting against this proposal. It appears to me that this proposal is not in line with the community sentiment and I don’t believe the explanation provided is sufficient justification. Furthermore, this is the first time I’ve seen the option for the 25% reduction. As part of the group working on V3 analysis, you supported the range of options we put forward and 25% reduction was not one of them.

On the org call, you made a comment that some people were surprised that we are considering a 50%+ reduction in incentives. My read is that we are talking about whales here. @Matthew_Graham brought up the concentration of DPI/ETH LPs multiple times and the impact of that on the distribution of INDEX incentives.

So if this is mainly about whales, I think Coop has the leverage in the current situation given that if an IIP doesn’t pass, the incentives stop completely. I understand the predicament given DPI is a whale product but at some point they will have to hold it without incentives. It’s in our interest to bring that point forward.

[oneski22]

Also having issues supporting this proposal, most likely going to vote against it. 25% seems to be very low.

IC products have other means of acquisition (mint/redeem) that other tokens don’t have. Whales will be able to use those flows.

[jdcook]

@overanalyser

Trade volumes have become subdued which makes it harder v3 LPs to be profitable (as IL is increased)

This is about v2, not v3. If trade volumes are subdued, then even if lowering incentives lowers our v2 pool, then we should be just fine.

@overanalyser

In addition the v3 pool is doing ~13% of the trade volume of v2.

The v3 pool will start doing more volume if the v2 pool drops some liquidity. Also, most large DPI purchases are using aggregators, and they barely utilize the v2 pool anyways? Why are we so scared of dropping some liquidity in v2 if it isn’t even serving us?

@overanalyser

Coop Eng resources to update our buy flows / deploy a v3 staking contract etc.

This is used for smaller buys anyways, so a smaller v2 pool shouldn’t matter. It was suggested that a $5m v2 pool would still support this.

@overanalyser

Managed LP services are being developed, but I don’t think any of them are ready for use with the “INDEXcoop seal of approval”

We shouldn’t be worried about v2 LPs being catered to on v3 as well. The truth is the v2 LPs and v3 LPs are not 1:1 and the v3 LPs will be providing a much more efficient service to the Coop anyways.

@overanalyser

Wanting to maintain our dominance of liquidity in the sector.

This is the only argument I think I consider, however, I think this is a bit of a vanity metric anyways given we are seeing smaller v3 pools provide better liquidity than larger v2 pools. Dominance of liquidity is no longer about a larger number, it is becoming more about user experience, capital efficiency, price impact, and liquidity efficiency.

I agree with @verto0912 and @oneski22 . My vote would be to drop 50% of incentives for this month. Mostly because I am not convinced that a $30m v2 pool gives us much of an advantage over a $15m v2 pool right now. Especially with our plans to migrate to v3 in the next couple of months.

Note: If I am wrong in any of my above statements/assumptions, happy to be corrected.

[BigSky7]

Lots of good discussions here. Increasingly, I see big LM campaigns as holdovers from the DeFi summer era. The reality is that no crypto protocol can sustain large-scale LM for longer than six months unless it is specifically incorporated into their economic model (like Curve and Sushi). LM is a band-aid for many protocols with poor products and undefined business models. Index Coop is neither. We are an established and mature protocol and our products speak for themselves.

I agree with @verto0912 here. If we suspect that a large reduction of LM will not negatively affect liquidity then I would rather have us do it sooner rather than later. DPI is attractive enough from an IL pair standpoint that LPs should feel comfortable holding it in a pool and earning trading fees without additional rewards.

With that said - **we should not begin to view V3 and increased capital efficiency as a panacea for all liquidity questions. V3 is a huge improvement on xy=k AMMs. But it will never fully solve the fundamental issues of impermanent loss and price impact in DeFi. Yesterday I spoke with a hedge fund looking to deploy a $70 million market-neutral DeFi fund specifically for trading - they specifically mentioned constraints around deploying capital based on the low liquidity across many tokens. The need for liquidity is not going away.

There is a strong potential that many of our products will need some form of liquidity incentives to scale (see the success of BTC2x-FLI on Sushi, without Onsen rewards I seriously doubt that that product would have as much liquidity as it does now). We need to further explore options outside of LM to support liquidity for our products. A few things come to mind, loans to market makers, loans to liquidity providing DAOs, UMA options.

On an unrelated note - several comments mention that DPI is a whale product. I believe this perspective has the potential to significantly constrain how we think about this product. While it is true that the majority of current holders are whales, that is a symptom of the types of people currently holding sophisticated DeFi financial products. Every new community member I speak with mentions buying DPI as one of the first things they did when they entered DeFi. We must not lose sight of the fact that this is a tremendously appealing product for all kinds of crypto investors.

@overanalyser has done a tremendous job managing our LM over the past 8 months. Without his hard work the Coop would not be where it is today. While I agree with the general consensus around significantly curtailing rewards moving forward (50% reduction is probably a safe step at this point) - ultimately I defer to his judgement here. He is the true expert and I trust his judgment.

[puniaviision]

I am in big support of this proposal and will be voting FOR.

Unit supply growth for the DPI over the past month has been non-existent.

At least half of the AUM is still concentrated with whales.

In order to combat 0-growth on DPI, we are engaging in protocol integrations [Aave] and direct sales [BD Team: DAOs, Conferences].

For protocol integrations, the existence of on-chain liquidity is incredibly important. Aave keepers need to have deep on-chain pools in order to sell the DPI into in the event of a liquidation. This feeds into the collateral parameters the DPI gets assigned [and, of course, whether it passes].

For direct sales, having accessible purchasing venues for the token is also incredibly important. Tokensets, and its related exchange issuance function, has significantly less distribution and accessibility than Uniswap v2 pools. We’ve seen large holders prefer to do multiple transactions on the Uniswap pool instead of engaging in an exchange issuance.

On July 15, the BD team is holding a large conference to present the Index Coop products to an audience of institutional investors. Presuming a successful event, such investors, who are used to the incredibly deep secondary markets for ETFs, are going to want to look at liquidity and other key metrics to buy the DPI.

What do we want them to see? Is the BD team prepared to explain exchange issuance? Are institutional tools these investors use deeply integrated with Set Protocol to the point where they can easily access exchange issuance? I would guess not.

I am aligned on moving liquidity to the more capital efficient Uniswap v3. However, as of today, we do not have the capacity to incentivize liquidity to come onto v3. Cutting liquidity on v2 with no plan to bring it immediately back onto v3 is a dangerous mistake as we are desperately trying to grow our products. Assuming that liquidity will flow to v3 is a big assumption that I don’t think is driven by data.

Another month of overpaying for liquidity for DPI while we are trying to grow the product and figure out how to integrate v3 is not going to kill us. This is also reflected in the fact that achieving cost-efficient liquidity is NOT a priority for the next quarter: Relentless focus: Q3-2021 Priorities.

Finally, I don’t think the teams recommending a 50-100% cut did enough active alignment well in advance to pursue such a drastic cut. As a leader of the PWG, I was not aware of the 50%-100% and the thinking behind them until very recently. I don’t know if other key stakeholders [DFP, BD, Growth, Set] were made aware of the considerations here for such a drastic measure.

I am happy to proactively help in this process next month to get an aligned proposal out, but trying to push something so drastic at the last minute, especially since other stakeholders will have no choice but to vote “FOR” because the alternative is nothing, is not how we want to run the Coop. That is not how we want to do business.

Finally, I want to push strongly against the idea that such decisions require full community consensus. Fundamentally, some community members have much deeper context than others and as such a vote doesn’t make sense. We should make our priorities clear, empower leaders, and let them execute against it.

I think a 25% cut is still reasonably aggressive, doesn’t torpedo our other initiatives and lets us observe where liquidity actually migrates to.

To reemphasize, I am looking forward to working with the Uniswap v3 team and others to proactively make this a reality come the following month.

[catjam]

Despite being (marginally) involved in the V3 discussions, I honestly still don’t feel like I have an educated enough opinion to weigh in. I’ll echo @puniaviision 's call for empowering leaders on this subject! It would be great to formally establish a Liquidity group and outline both their responsibilities and guardrails (what are the changes big enough that they need to go up for a feedback or a vote?)

Big ups to BigSky’s comment here too. @Financial-Freedom recently showed off some of his work on personas and noted the popularity of DPI with Fund Managers and non-crypto natives. (Excited for the wider community to see this work on a future call!)

@BigSky7

On an unrelated note - several comments mention that DPI is a whale product. I believe this perspective has the potential to significantly constrain how we think about this product. While it is true that the majority of current holders are whales, that is a symptom of the types of people currently holding sophisticated DeFi financial products. Every new community member I speak with mentions buying DPI as one of the first things they did when they entered DeFi. We must not lose sight of the fact that this is a tremendously appealing product for all kinds of crypto investors.

[Matthew_Graham]

Annualised loss of nearly $9M if we continue as we have with LM on DPI.

Only sharing for transparency and we did intend on showing annualised returns per product. But when the numbers are like this, not sure we should. If we did, it would be good to have a longer term understanding of how much DPI will cost Index Coop.

[jdcook]

Really appreciate all of the discussion here, I know I threw in my points of feedback throughout, so I just wanted to make it clear that I am FOR this proposal, and look forward to work with @overanalyser, @verto0912, @Matthew_Graham, @puniaviision and others on the next iteration!

[Don-ETH]

Personally, 50% reduction is a better option. I will vote AGAINST for this because of the quote below. I believe, the main purpose is LM is to provide better UX (less slippage, etc.) but only having 12% of whale traders being routed to V2 is an indicator that we should stop LM soon.

@overanalyser

If we look at 1inch, for large trades (100 ETH), many liquidity sources are used. In this case, less than 12% of the total volume was routed through the Uniswap v2 pool!