OK, we had quite a long discussion back in February about liquidity mining, however, I’m not sure we have a strategy that is fit for purpose going forward:
So, I’m going to try and restart the discussion:
Liquidity Mining Strategy
Until now the coop has managed liquidity mining by a combination of:
- The initial Coop launch
- IIP’s for specific product LM programmes
- GWG grants for loopring incentives
As time has progressed the calculation of rewards has developed into something based on the framework:
- A target AUM and assumed APY (for product launches)
- A target AUM and the current incentives (so if we have more liquidity, rewards are cut in proposition)
This approach has worked and we have managed to successfully launch products with and without LM.
However, with the launch of more products, and multiple L2 options becoming available, i think it’s time to review the coops strategy and see if we want to change it:
Why does the coop run liquidity mining?
LM can be used for a number of reasons for the benefit of holders, LPs and the coop:
- It’s a provably neutral way to distribute tokens and so help decentralise a protocol.
- It can generate hype for new products to encourage people to look at them.
- It can help offset the cost of ownership for liquidity pairs which have large risk of Divergence Loss.
- Large liquidity allows larger trades to occur with minimal price impact.
- Large liquidity means that arbitrage via the issue and redemption contracts becomes favourable at a lower discount / premium to the NAV.
- Large LM rewards will drive an increase of AUM.
#1 is essential for a DeFi protocols early days. A period that I would say the coop has passed as we have > 14% of total tokens circulating on the open market…
#2 The marketing impact of launching a product and offering xxx% LM rewards and the associated early growth in AUM is clearly a benefit to the coop.
#3 Divergence loss can be reduced by creating pairs that are expected to be reasonably correlated over time (DAI:SYI, ETH:DPI), or where the LP is expected to be reasonably happy with either token (BTC2-FLI:BTC). Where the use case results in a higher risk (e.g. sUSD:SMI) then rewards may need to be higher.
4# For standard xy=k (uniswap v2, Sushiswap etc) DEX’s. Larger pools allow larger trades for a given amount of price impact. The introduction of Uniswap v3, means that these simple calculations become invalid.v3 is reported to be 10x (???) more capital efficient - a $1M pool on v3 can provide the same purchase experience as a $10M v2 pool.
With the availability of exchange issuance (i.e. ETH → underlying tokens → fund token), there is an upper limit to trade sizes where further increases in pool size have little impact on the user as the purchaser would be better using the contract than the DEX liquidity.
#5 Cost effect arbitrage via the issue and redeem contracts is a factor of the number of tokens in the fund (impacts the gas cost of the issue), the gas price, the size of the pool and the premium / discount to NAV. A pool that needs a $500,000 transaction to return to NAV is much more likely to be arbitraged than one that needs $50,000.
Note: Index products are different to single tokens, for single tokens, arbitrage is between the different markets (DEX’s and CEX’s) based on the difference between them. For index fund tokens the reference point is the NAV and the cost of issue / redemption.
#6 is an interesting one to think about, if we increase LM massively, will we induce more AUM, or move non incentivised AUM into incentivised AUM?
What is the optimum customer experience for holders?
I would say that the optimum experience is for the customer to have access to buy or sell the index fund as close to the NAV as possible with the lowest cost.
- For very large purchases, this would be direct exchange issue/redemption on L1.
- For large trades, this may be a large liquidity pool on L1.
- For small trades this may be a smaller pool (with more slippage / premium / discount to NAV) on a L2 / side chain (or even a CEX) where gas fees are lower.
To me, this means we need a large L1 pool so that the issue and redemption arbitrage is effective, we also need effective arbitrage between the L1 and L2 pool - Which I’m not sure is happening yet.
What is the optimum customer experience for LP’s?
I would say that LP’s would like a combination of:
- A desirable pair to own long term - I’m happy to hold ETH:DPI long term, I would not like DAI:DPI.
- High trading fees - which implies large volume compared to the pool size.
- High LM rewards - although this is largely set by the market, if we double the incentives, we can expect more liquidity the LP would get a similar reward APY.
- Note a Low APY is a good thing for the coop, it means that the market place for LP assets is happy to sit in a pool containing our products. I also means that we get maximum impact for our
- Rewards paid in a token they desire - not something they plan to harvest and dump frequently - Whales will farm and dump quicker.
- Unvested rewards
- Low maintenance staking - i.e. no need to unstake and restake every x days.
- Clarity on the length of staking / rewards. [I’m much more likely to enter a pool that says 100 + days to run than one that ends in a week].
- L2 / sidechain LP’ing and staking has obvious gas savings.
What is the optimum customer experience for the coop?
If we think of the coop as the customer, what do we want from liquidity mining?
- Good holder experience
- Good LP experience
- Cost effective
- Predictable costs
- Does not require excessive governance / smart contract dev / web UI dev.
- Minimises questions / questions in the forums.
- Drives Coop vision:
- $500 m AUM
- 400,000 DPI units
- New products > $200 m
- I suspect some of these are pulling us in different directions. So we need an agreement on which we prioritise.
Where are we at the moment?
The current situation is that each product has IIP’s related to liquidity mining which creates work and uncertainty over the length of LP rewards.
IIP-24 and 28 produced 90 day campaigns with three x 30 day periods and a mandate to modify the rewards to target a liquidity value. I think that this has been an improvement for both LP’s and the coop, but I think that there is still scope for further iteration.
With the ongoing discussions around multichain (which may include liquidity mining) and delegation of responsibilities within the coop I think there is likely to be some move to delegate/automate the management of liquidity mining for the coop (before we are swamped by IIP’s)
I don’t have all the data to hand, so we will need input from the analytics team (and @geroge’s analysis of trade sizes).
But, before we can do any such delegation, we need a Liquidity mining strategy.
Options for potential strategies include:
- Allocating target Liquidity for each product over an extended period (90 day, 180 days) and modifying the rewards every 30 days to target the liquidity
- Target could be flat, increasing or decreasing
- Allocating a fixed number of INDEX tokens to Liquidity mining over a period and then a delegated group allocates it to different products / pools
- LM incentives are focused on product launch, and removed within a set period.
- Liquidity mining rewards are increased to drive AUM to $500 M
- The coop moves to curve like tokenomics with planned token inflation focused on liquidity mining to drive AUM / growth
- Liquidity mining is cut to make each product a net cash generator for the coop.