Reconstruction of Liquidity Relationship in DeFi 2.0
Over-exploitation of liquid mining
The pace of DeFi is fast. Last year we witnessed a turbulent DeFi. At that time, DeFi adopted a liquid mining model, which detonated the entire encryption field. But with the exploration of the liquidity mining model, people have gradually discovered the drawbacks of liquidity mining. This short-term incentive model will cause some liquidity providers to over-explore projects and agreements, and even accelerate the demise of projects.
In this model, the long-term interests of the liquidity provider and the agreement are not consistent, and the existence of this contradiction leads to a slow growth of DeFi. Of course, this is only one reason.
In this context, the concept of DeFi 2.0 came out. Here, we are not arguing about the definitions of 1.0 and 2.0. Because it doesn’t make much sense, calling it 1.0, 2.0 or even 3.0 can’t change the essence of things. This article is mainly to briefly introduce the new changes of DeFi. The use of DeFi 2.0 here is more for the convenience of introduction and also a brief description of the evolution of DeFi.
DeFi 2.0 changed the relationship between the agreement and the liquidity provider through a new mechanism, and finally reconstructed the liquidity service itself.
Liquidity capture of DeFi2.0
People generally pay attention to the capture of agreement fees. But from the perspective of the long-term sustainable development of the agreement, the liquidity capture of the agreement is equally important. The liquidity capture of the agreement is an important part of distinguishing DeFi 1.0 and 2.0. The other is the improvement of capital efficiency.
In addition to the underlying public chain infrastructure such as Ethereum, the most important reason why DeFi can become DeFi is the provision of liquidity. This is the prerequisite for DeFi to operate and the blood that supports its life. This is also an important reason why the entire market was detonated after Compound launched liquid mining in the summer of 2020.
With more than a year of practice, people have seen the drawbacks of liquidity mining. Short-term incentive models will only encourage short-term behavior of liquidity providers. The additional issuance of tokens enters the hands of liquidity providers. In many cases, liquidity providers have not formed a long-term mutually beneficial cooperative relationship with the agreement. The liquidity provider can retreat at any time and leave it to the agreement.
To solve this problem, the concept of POL (Protocol Owned Liquidity) emerged, which is the liquidity controlled by the protocol. Blue Fox notes call it “liquidity capture”. There is even a “liquidity layer” service that focuses on providing a liquidity infrastructure layer for DeFi projects.
PCV and POL
As mentioned above, POL refers to Protocol Owned Liquidity, which is the first concept practiced by Olympus DAO. Regarding Olympus DAO, Blue Fox Notes introduced “Ohm’s Algorithmic Stable Coin Exploration” earlier this year. But now Olympus has changed a lot.
It is different from the previous popular liquid mining model of DeFi. One of the cores of Olympus DAO is PCV. That is, the agreement controls the value, which changes its relationship with the liquidity provider. Olympus flows money to the agreement, not the team. The agreement uses the funds of these early backers to provide liquidity.
Olympus DAO issues discounted OHM tokens (bonds) to participants to obtain LP token positions from liquidity providers, thereby capturing “liquidity”. Olympus DAO’s treasury has mastered liquidity. Although its OHM is increasing, the more its bond sales, the greater its liquidity. Up to now, Olympus DAO has more than 460 million US dollars of liquidity.
The “liquidity” captured by the agreement is not freely controlled by the LP, but is controlled by the agreement, which means that there will be no “Rug Pull” where liquidity suddenly disappears, thereby ensuring the possibility of withdrawal of participants. At the same time, the agreement participates in the provision of liquidity, becomes a market maker, and can obtain transaction fee income. So far, it has obtained more than 10 million US dollars in fee income.
Better liquidity can increase participants’ confidence in continued participation. Don’t worry about the sudden disappearance of liquidity one day. This is also a common situation of Rug Pull in the early DeFi mining era, causing heavy losses for many participants.
Of course, this is not completely safe. It’s just that, relatively speaking, it is better than the previous liquidity support. With the success of Olympus DAO, there are now as many as ten similar projects on each chain. The risk here will get higher and higher, and the Olympus DAO model does not guarantee that there will be no Rug Pull.
Based on Olympus DAO’s own successful practice, it has also launched liquidity service products that can be adopted by other DeFi protocols. Other projects can achieve “liquidity capture” similar to Olympus DAO. At the same time, Olympus can also embed its token OHM into more protocols to form more application scenarios. For this method, someone even proposed the concept of Liquidity as a Service. This is the further evolution of the DeFi liquidity scheme mentioned below.
Focus on the agreement of liquidity provision
As mentioned above, the concept of LaaS liquidity as a service, other DeFi agreements can buy liquidity from the market, and the market will compete to provide higher quality and better price liquidity, forming a relatively balanced state.
Tokemak is one of the agreements that focuses on liquidity supply. In short, it tries to become a market maker for DeFi projects and an infrastructure layer provided by DeFi’s liquidity.
On the TokeMak protocol, it can collect various idle tokens, and participants can provide unilateral tokens. These include tokens such as ETH and DAI, as well as tokens for different protocol projects. These tokens can be formed into token pairs to provide liquidity. Each token asset has its own “reactor” (when a liquidity provider deposits a token asset, it will get a corresponding amount of t assets, which can be redeemed 1:1). TokeMark’s protocol token TOKE acts as a guide to liquidity, which can also be understood as tokenizing liquidity. TOKE controls the flow of liquidity.
For DeFi projects, TokeMak can build a “token reactor” at a lower cost to build sustainable liquidity. For liquidity providers, they can provide unilateral token liquidity without worrying about impermanence losses. Ultimately, it hopes that various agreements will no longer build liquidity pools by themselves, but will obtain liquidity through TokeMak.
For liquidity providers, they can deposit tokens in the “token reactor” to obtain the reward income of the protocol token TOKE. These token assets deposited in the “reactor” are paired with assets such as ETH or DAI and deployed in the DEX. These tokens deposited in the “reactor” can be redeemed 1:1. So, if impermanent losses occur, who will bear it? Here is the TOKE token. TOKE token is Tokemak’s protocol token, which not only has governance functions, but is also used as a reward for liquidity providers. TOKE tokens can capture liquidity transaction fees, which is the key to supporting its value. At the same time, it is also used to ease the loss of impermanence.
If there is an impermanent loss when a certain “reactor token” is withdrawn, then TOKE will support the payment. TokeMak uses a mortgage network to mitigate impermanence losses. In TokeMak’s design, in addition to liquidity providers, there are also liquidity guides. The liquidity leader guides liquidity by staking TOKE. In this process, the liquidity leader will be rewarded with TOKE tokens. If an impermanent loss occurs, it will first be supported by the agreement treasury, and finally will be supported by the TOKE reward of the TOKE pledger (liquidity leader). If this is not enough, it will be supported by the TOKE of the TOKE pledger (proportionally) .
For the TokeMak agreement, its long-term purpose is to build a service that provides liquidity and market making without third-party participants. Its method is to accumulate more and more value in the liquidity provision service, and then this part of the value is transformed into liquidity provision. Of course, the premise is that it has enough network effects and accumulates enough value in the process. Once the value breaks through the critical point, it may produce a black hole-like effect. Of course, before reaching the critical point, there will be many stages, which is not so easy.
The Fei agreement also attempts to provide liquidity services, and it cooperates with some DeFi projects to provide liquidity leases for them. For example, deposit its tokens in other DeFi liquidity treasury for a period of time, and then provide the liquidity of “project token/FEI” in DEX. Of course, at the same time, FEI can also charge certain fees and transaction fees, but there are also potential impermanence losses.
DeFi 2.0 asset efficiency optimization
Due to DeFi’s disintermediation model, it is often necessary to provide over-collateralized assets. There is a situation of low asset efficiency here.
The Abracadabra model is similar to MakerDAO in that they are all over-collateralized assets to generate stablecoins. However, unlike MakerDAO, the assets pledged by Abracadabrao are assets with income, which is equivalent to improving the efficiency of funds for users of mortgage assets. Because these mortgage assets themselves are still receiving income. These assets with yields include yvYFI, yvUSDT, yvUSDC, xSushi, etc. Over-collateralization of this type of asset can generate its stable currency MIM.
In addition to improving the utilization of funds, it also reduces the possibility of liquidation. Because these mortgage assets will add value. This is a type of innovation based on user needs.
The risks of DeFi 2.0
Since DeFi has a large number of DAO to DAO combinations, there is a greater risk of composability. For example, an agreement like Abracadabra, once the agreement to mortgage assets goes wrong, then it will also go wrong. Therefore, while we see its advantages, we can also see its potential risks.
In addition, DeFi 2.0 does not guarantee that there will be no Rug Pull, and risks will be everywhere before the formation of its own sustainable liquidity. Therefore, don’t be fooled by the concept of DeFi2.0, which is also full of extremely high risks.
DeFi 2.0 essentially completes the infrastructure layer of DeFi
DeFi’s infrastructure not only includes Ethereum and so on. Not only does it include basic Lego blocks such as DEX, lending, and derivatives, it also includes the liquidity that supports these models, and liquidity itself is also an important and sustainable infrastructure layer for DeFi.
The core of DeFi 2.0 is to turn liquidity into the infrastructure layer of DeFi, and on this basis, make DeFi more sustainable. From this perspective, DeFi 2.0 itself is an inevitable evolutionary trend of DeFi. DeFi is like a living body. It needs to improve its parts in order to grow continuously, and eventually become a self-reinforcing and sustainable technological evolution trend that can be independent of any intermediary.