Liquidity Mining Philosophy Discussion

[mel.eth]

This post is meant to foster discussion and state my views - I don’t intend to guide the conversation but I will respond if questions are posed with an @ and add some sentiment polls after a bit, as I think it’s important to know how the broader community thinks about these issues. Most relevant previous post: Liquidity Mining Framework by @verto0912 @Matthew_Graham @BigSky7 . Adding @overanalyser as well, mainly to snap me back into line if I say anything too ridiculous.

Context: INDEX is a Governance Token
1 INDEX:1 Vote . . . that’s really all INDEX tokens represent at this point. An argument could be made about future earnings, metagovernance, etc, but there is no current tokenomic model for INDEX that has any value accrual to holders beyond governance afaik. I’ll refer to INDEX tokens as ‘equity’ for simplicity.

Why do we incent liquidity?
I know why SUSHI needs liquidity - it’s the lifeblood of a DEX, and while users may get a one-off airdrop, liquidity providers are adding very-much needed value to the UX (less slippage, increased routing likelihood). The Coop on the other hand doesn’t need liquidity for the same reasons; we have a gas-heavy mint-redeem function that can be called (and is still the better option for large trades).

So do we need liquidity?
Yes - having a token that isn’t liquid won’t gain wide protocol adoption, and having a token that isn’t composable isn’t very “DeFi”. In essence, IC needs products to be liquid to a point to maintain a positive UX.

How much liquidity do we need?
There is a lot of discussion about this, and typically the answers get subjective quite fast. Personally, I feel that any slippage greater than the mint-redeem cost is not ideal - but again you’ll get as many answers here as we have contributors that are brave enough to jump into the conversation.

Why do we incent liquidity with equity? (i.e. why give INDEX rewards, why not ETH or DPI?)**
Short answer I imagine is - “it’s what The Coop has had to work with” - but that’s changing. I think there’s a sort of lazy-thinking philosophy around LM (ecosystem-wide, not just IC) of, “We’ve got these native tokens, we need liquidity, let’s use that to make it happen.” As the treasury becomes more diverse would current INDEX holders be open to incentivizing liquidity with other tokens in the treasury? Personally, I find the thought of giving large amounts of equity to those that are unlikely to value it as such (or worse may have motives that don’t align with our core principles and desire for sustainable growth) to be untenable.

What are the alternatives? (As I see it, please add to this in discussion, there’s infinite whitespace here)

• Incent nothing (current strategy for FLI products, those seem fine but don’t currently need composability)
  • Upside: Community treasury is not depleted
  • Downside: Increased volatility, reduced composability/adoption
• Adjust parameters (incent more/less - this is the current flavor on offer for DPI & MVI)
• Get creative
  • Do a one-time incentive for a 3 or 6-month liquidity lock (whoever is in by a certain time get’s all the rewards, can’t unstake for set period of time)
    • Adds predictability, min liquidity (Maybe have an emergency unstake function just in case it gets weird)
    • Still likely costly
  • Incentivize Coop native pairs (MVI/DPI, INDEX/DPI???)
    • With the rise of 1inch etc, it will route through whatever is liquid and fracture as necessary, so would likely get decent action if large enough
    • Less IL with DPI base pair (maybe, I have not run the numbers, but it makes sense to me in theory)
• Fund LP pools with a loan from treasury
  • High risk (market, protocol), high reward (most of the trading fees until natural LPing arises), reduces optionality (can’t use that treasury money for other things)

My current takes:

• The current LM strategy is in direct opposition to some current strategic goals: treasury management, value capture, governance, community - all of these are negatively impacted by attempting to incentivize potentially non-aligned actors with equity in a community driven protocol. In short, we shouldn’t be incentivizing short-term behavior with outsized governance power.
• LM should be a bootstrapping mechanism with defined timelines, if at all (i.e. if our products don’t find PMF we need to respect that and move on)
• Forming an LM committee (‘dedicated team’ suggested in previous LM philosophy post linked above) without clearly defined mandates will shift our biggest treasury spend (and by default, governance distribution) out of the broader community discussion. Essentially, first things first, let’s figure out what we’re trying to accomplish with LM and then organize around a philosophy.

The Coop needs a defined LM strategy with broad community buy-in. Emotions tend to get a little high (I go up an octave when talking about this for more than 5 minutes - I get it), but I think it’s foolish to be discussing how much LM we should be providing as a matter of degrees when as of yet I have not seen a discussion about LM, specific to our products and overall philosophy, that convinces me that we need it in its current form. I’m hoping some discussion here helps inform my thinking as I don’t feel like I have my arms fully around this wildly complex topic yet - and as always, if there are errors in fact above let me know and I will expeditiously correct them.

[jdcook]

Hey @mel.eth - awesome to see you thinking in depth about liquidity! This has been on my mind a lot lately as well. I think you might be aware of discussions going on within the PWG to create a couple liquidity teams similar to the FLI experts team that can act with more speed and alignment regarding liquidity across the Coop’s products. It is my vision that this team does exactly what you are doing here - open up all the options. We don’t need to constrain ourselves to just the liquidity mining framework (although that may continue to be a tool we use). So, part of this charge for this team should be to re-frame the problem of liquidity and explore all possible solutions - similar to what you are doing in this post! I am in total agreement that we need to refine our broader liquidity philosophy.

[overanalyser]

Hi @mel.eth

You make many very good points and this is an area where we need attention and challenge to prevent groupthink in this area.

I’m going to add some thoughts to various points:

As a minimum, I would like secondary liquidity to allow small trades to happen without significant price impact. For many of our products this issuance arbitrage is effective at ~$10,000 trade size, so we don’t actually need that big a pool on L1 to allow the p[rice to be anchored to the NAV.

As you say, larger secondary market liquidity becomes subjective very quickly. I see it as giving more confidence to both larger passive holders, and to active traders. The first drives AUM, the second drives trade volumes. I think that volume is important as lending protocols look at volume as part of their assessment of any prospective collateral.

Using the native token for incentivising liquidity is extremely common across DeFi (which doesn’t mean it’s the way the coop should do it). I think this is for a few reasons:

1. Protocols have lots of the newly minted governance token, and little else of value.
2. It is a provably neutral way to disperse ownership of a protocol as it tried to migrate to a DAO.
3. Selling the governance token to load into a staking contract will tank the price (particularly early days) while depositing the governance token into a contract to be released over 30 days slows the dumping.
4. LM with the governance token transfers some of the risk to the farmers (which may mean we are paying more than if we paid in MVI or DPI).
5. IF we give people governance tokens, they may take the time to look into the protocol more deeply and decide to hold/buy more / become a contributor. If we give them DPI, they may never look at the Discord.
6. In addition, many LP farmers retain the governance tokens long term*

Note:* I personally farm some pools because I want the governance token, but I don’t want to make a purchase. It may be irrational, but I like free stuff (even if I don’t see the Divergence loss from the pool…). As an example, I have farmed more Sushi than I have purchased.

I like predictability and communication around LM rewards and this is an area where I/the coop can improve.

Coop pairs, or even balancer pools could be interesting options.

I agree that we need a philosophy around liquidity, and I feel that the current system is unsustainable (in terms of INDEX spent and governance overhead).

I don’t think any of us have a complete picture, nor all the answers.

I see no errors in what you are thinking or writing, I see a fellow member of the coop trying to figure out the complexities of liquidity.