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Analysis of Revenue Sharing

Dec 28, 2023
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At this juncture, there seems to be a growing consensus within the cryptocurrency community regarding the transition of tokens from pure governance instruments to those that contribute to value accrual. This evolution can take shape through various models leveraging protocol revenue:

  • Acquiring the protocol token from the market and distributing it among stakeholders (e.g., xSUSHI).
  • Procuring the protocol token from the market and implementing a burn strategy to decrease the token supply (e.g., CAKE).
  • Purchasing the protocol token from the market and storing it in the treasury (e.g., YFI).
  • Redistributing a portion of the protocol-generated revenue to token holders in major tokens, offering a source of cash flow (e.g., GMX).

The first three methods primarily enhance the stake of each holder in the project, establishing a consistent buying pressure on the token. Meanwhile, the fourth approach provides token holders with cashflows, enabling them to make decisions on whether to reinvest or diversify into other assets.

In the dynamic realm of crypto-economic systems, the delicate interplay of mechanism design and token distribution stands as a pivotal force. These mechanisms aim to reward agents for their diverse contributions, be it the endeavors of block producers or the commitment of investors to capital and liquidity. This brings us to the intriguing concept of liquidity mining, a strategic initiative that has taken the crypto world by storm.

The Rise of Liquidity Mining

Liquidity mining programs emerged as a beacon in 2020, wielding transformative success in bootstrapping adoption. This innovative approach not only gained traction but also played a crucial role in illuminating the vast potential of Decentralized Finance (DeFi). At its core, liquidity mining serves as both a bootstrapping mechanism and an incentive strategy. The rewards, often in the form of the protocol’s native token, are distributed to liquidity providers, enhancing their capabilities and fostering long-term organic growth.

Unveiling the Mechanics

Liquidity mining is a cost-efficient strategy that has become ubiquitous across various protocols. Nearly every notable player in the crypto space has either embraced or continues to leverage this mechanism to incentivize both liquidity providers and users. The success lies in its ability to subsidize costs effectively and generate enduring ‘network effects’ of liquidity and volume beyond the immediate utility of the product.

Key Considerations for Effective Liquidity Attraction Nowadays

As suggested by Gauntlet, the design of incentives in liquidity mining programs must adhere to three fundamental principles:

1. Enhancing Liquidity Equilibrium: The true test of a successful liquidity mining program lies in its ability to sustain liquidity levels even after incentives are removed. While a temporary dip is expected, the overall liquidity and fees should surpass the pre-incentive era.

2. Strengthening Provider Loyalty: The program’s efficacy hinges on the “stickiness” of liquidity providers. Ensuring that providers remain committed following token distribution, and resist the allure of alternative protocol incentives, is paramount to long-term success.

3. Sybil Resistance: To maintain integrity, any incentive program must be fortified against exploitation. Gauntlet emphasizes the importance of making the program challenging, if not impossible, to exploit, thus safeguarding the system from malicious actors.

Unpacking the Challenges of Early Liquidity Mining: A Critical Analysis

While the concept of liquidity mining has gained traction in certain circles, a closer examination reveals significant challenges in its early iterations. This analysis delves into the inherent issues that have hindered the establishment of sustainable flywheels and optimal incentive alignment.

Problem 1: The Inflationary Dilemma

One major hurdle stems from the inflationary nature of assets, leading to a consistent downward trend over time. In this context, we spotlight the core issue of incentive misalignment between the contributors driving protocol growth and financially motivated mercenaries. The increasing circulating supply dilutes the value claim on each token, raising concerns about governance dynamics and concentrated voting power.

Problem 2: The Yield Paradox

A crucial aspect of liquidity mining lies in the dependence on the sale of native tokens to realize yields. This creates a pre-committed and programmatic economic force, presenting liquidity providers with a classic Prisoner’s dilemma. Despite the potential for superior economic outcomes by abstaining from selling, the local rationality for self-interest leads to a cycle of selling before the next liquidity provider, perpetuating the supply capital → receive rewards → sell loop.

Problem 3: The Mercenary Dynamic

Liquidity mining participants, driven by profit maximization, often lack “stickiness”, and direction of emissions resembles renting liquidity rather than fostering long-term economic growth. Non-loyal liquidity providers, acting as mercenaries, tend to rotate towards alternative yield-bearing opportunities, hindering sustained growth.

Problem 4: Reflexivity and Token Value

Examining the reflexivity bound system, the depreciation of the emitted token’s value diminishes the effectiveness of incentives in siphoning liquidity. There is an inverse relationship between token value and the system’s overall effectiveness, emphasizing the need for a nuanced approach to maintain stability.

Onchain capital movements and historical implosions (e.g., OHM) suggest a weak statistical relationship between liquidity mining and the retention of liquidity over the long term. For instance, Nansen reported that the majority of farmers exit within 5 days of entering a farm. Seemingly, buying growth with dilution is only sustainable when the equity value outpaces the issuance rate. As such, investors have a preference for yields being paid in majors (BTC/ETH/stables) rather than protocol native tokens that allow them to estimate with a bigger degree of certainty the return of their strategies.

Real Yield in DeFi

Born from the ruins of liquidity mining, ‘real yield’ introduces a groundbreaking emissions design philosophy. Unlike fixed emission schedules, real yield ties APR outlay to a protocol’s revenue, predominantly derived from fee generation. This innovative approach challenges traditional financial models, emphasizing a measurable connection between sustainable economic growth and the associated costs.

Real Yield in Traditional Finance vs. DeFi

In the realm of traditional finance (TradFi), real yield traditionally measures nominal returns minus inflation. For DeFi, however, it takes on a new meaning. Real yield in decentralized finance has become synonymous with the returns generated by economic activities and fees obtained from services provided by protocols. This revolutionary concept also introduces a model where the user returns hinge on protocols sharing their revenue for staking or locking tokens. Crucially, this revenue must be denominated in blue-chip crypto assets or stablecoins, ensuring enduring value over time and excluding inflationary, farm, or rebase tokens.

Why has real yield suddenly captivated the imagination of the DeFi community? In essence, it marks a departure from the mindset of “free money printed out of thin air.” Formerly entranced by high APYs, DeFi users now face a sobering reality, akin to the aftermath of the ICO bubble burst.

Navigating the DeFi Landscape: Learning from Mistakes

The DeFi community has become more discerning about seeking yield opportunities, even when they seem foolproof. A recent cautionary tale revolves around Terra’s enticing offer of a 20% APY on UST stablecoins. While seemingly conservative against other high APY products, this payout was sustained more by a marketing budget than by the fundamentals of economic activity or lending.

The collapse of UST stability due to a significant portion of its supply being deposited on Anchor serves as a stark reminder. What seemed like a surefire return turned out to be a house of cards, vulnerable to a bank run. Without solid fundamentals supporting UST adoption, Terra and its users inadvertently created an unsustainable scenario, illustrating the risks of chasing illusory yield without a foundation of economic activity.

Can DeFi Protocols Provide Real Yield?

In the fast-evolving world of decentralized finance (DeFi), the quest for real yield is a pivotal aspect that separates legitimate projects from fleeting trends. But how exactly can DeFi protocols deliver on the promise of substantial returns for their users?

Building Revenue Streams for Sustainable Yield

For a DeFi protocol to truly provide real yield, it must establish revenue-generating services that users find valuable enough to pay fees for. As the saying goes, “when incentives are gone, what’s left?” Legitimate projects understand the necessity of building services that stand the test of time.

While some projects bootstrap their journey with inflationary token rewards, this doesn’t necessarily undermine their legitimacy. Notably, tokens can serve as powerful incentives, akin to how Solana and Bitcoin use them to encourage validators to honestly finalize new blocks.

In the ever-evolving DeFi landscape, governance tokens have emerged as key players for decentralized autonomous organizations (DAOs). However, recent observations indicate that these tokens are better suited for voting on improvement proposals than for generating profits. A governance token, when structured as a cash flow token, can become a source of genuine yield. The secret ingredient lies in the capital entering the protocol through fees. When a protocol collects fees, it opens up the possibility to share revenue with users who actively support the platform by staking or locking their tokens.

Landscape of the “real yield” market

Decentralized exchanges have been innovators in the realm of real returns. Indeed, if your liquidity pool consists of two stablecoins, it is quite easy to give the liquidity provider a real stable return on the intensity of exchanges of stablecoins in the pool. And although most protocols that have already become large, such as Curve or GMX, prefer to simply distribute part of the income to stakeholders in the form of both “blue chips” of cryptocurrencies and their own protocol tokens. While new fresh Web3 projects are actively experimenting with new formats to give their clients Real “real yield”. Let’s analyze how web3 projects from a variety of quite different sectors share Real “real yield” with their clients.

  1. The DEX Classic: GMX and Curve+ConvexGMX stands out as a beacon of real yield success. Users providing liquidity (LPs) receive 70% of GMX’s revenue through the GLP token, while the remaining 30% is distributed in ETH or AVAX, depenSding on the chain, to users who lock in their GMX tokens.

Achieving real yield, however, requires users to stake or lock their tokens for a specified period. Impressively, GMX boasts an 86% staking rate, showcasing a strong commitment from its user base.

Other notable players in the DeFi space, such as Curve and its associated yield optimizers like Convex, offer users a chance at real yield. Locking CRV, for example, earns users a share of fees in the form of 3CRV, equivalent to holding a position in stablecoins. Yet, it’s crucial to note that some of the yield is sourced from inflationary rewards and incentives.

  1. On-Chain Betting: Azuro (USDT APY 3.8–17.66%)

Azuro operates as an infrastructure and liquidity layer for on-chain betting, employing the Liquidity Tree design to maintain market liquidity across numerous sports markets. The platform distinguishes itself by rewarding various contributors — Affiliates, Liquidity Providers (LPs), Data Providers, and Azuro DAO participants. Each contributor’s role corresponds to a specific reward structure, ensuring fair distribution and real yield. For instance, LPs and Data Providers receive rewards based on pool profit or loss (25% and 10% respectively), while Affiliates gain 2% of the betting volume associated with their address monthly (up to a maximum of 70% of the pool’s profit). This multifaceted reward system ensures users enjoy tangible returns from their contributions.

  1. Cross-Chain Bridges: Connext (USDC APY: 0–11.8%)

Connext stands at the forefront of enabling communication of data and funds between chains and rollups. Recent liquidity initiatives aim to enhance liquidity availability by introducing two types of liquidity, active and passive, as well as nextTokens — an internal unit of account representing a router’s ownership of locked funds on Ethereum L1. By providing stablecoins as liquidity to Connext, users gain access to real yield through cross-chain transactions of other users, paying fees in stablecoins and enjoying the distribution of real yield.

  1. Stablecoins Revenue Sharing: Spark (DAI APY: 4.2–5%)

Spark facilitates users in depositing volatile ETH, borrowing stable DAI, and expanding their crypto holdings without sacrificing exposure. Through SparkLend and sDAI, it integrates with MakerDAO, providing tangible real yield. Revenue generated from fees within SparkLend is distributed to stakers, offering them a share in protocol profits. Additionally, sDAI, a yield-bearing stablecoin tied to the Dai Savings Rate (DSR) module, ensures users earn real yield derived from protocol-generated revenue, emphasizing sustainability and returns for participants. ​​In addition to facilitating direct borrowing of DAI against various assets, users can also deposit ETH, earn fees, avail of the recently increased DAI Savings Rate (DSR), and swap stablecoins such as DAI or USDC with no slippage.

  1. Derivatives Trading: Holdstation (USDC APY: 42.6%)

Holdstation DeFutures serves as a cutting-edge trading platform offering leverage up to 500x. The Defuture Vault stands as a pivotal feature, allowing traders to earn real yield by splitting trading fees. The vault’s segregation into different categories — Crypto, Forex, and Commodities — ensures risk mitigation and varying potential returns, providing traders with opportunities to amplify profits from market movements.

  1. Delta-neutral strategies: Resolv Labs (APY: 9–12%)

Resolv Labs takes a novel approach to real yield by developing Resolv, a stablecoin architecture backed by on-chain assets. As part of its go-to-market strategy, Resolv Labs seeks early pre-launch liquidity commitments from dedicated liquidity providers. The liquidity is allocated equally (50%/50%) into two core products: the stablecoin (USR) and the protection layer (RLP). In return for providing liquidity, LPs receive the Base Rate plus Incentives, with the Base Rate determined by the real yield generated through the delta-neutral strategy underlying Resolv’s architecture. Resolv benefits from two major sources of yield — ETH staking and funding rates generated by perp futures positions.

  1. Leverage Protocols: Marginly (APY: 0–1%)

Marginly introduces a smart solution to the challenges of generating real yield by enabling margin trading and derivatives on top of existing AMM liquidity. Acting as a side pool for any DEX, Marginly handles leverage funding mechanics independently, requiring only the execution of actual trades from the DEX. This seamless integration allows DEXs to offer leveraged trading without significant development effort, instantly enhancing their product offerings. It modifies the uninspiring product offering to instantly become much more appealing for both traders and liquidity providers.

Marginly’s revenue model includes a 0.1% fee on each trade, with liquidity providers receiving 40% of trading fees. Additionally, DEX partners benefit from Marginly’s on-chain RevShare program, receiving up to 50% of total fees when a trade is routed through their platform. This innovative revenue-sharing mechanism empowers DEXs to capitalize on new opportunities, fostering sustainable growth and real yield for clients.

Real Yield: A Path to Sustainable DeFi

Does real yield pave the way for better sustainability in DeFi? The answer is uncertain, as the space is known for its rapid evolution and constant innovation. However, there is a growing sentiment within the DeFi community urging caution against blindly embracing projects that promise unrealistically high yields.

Shifting the narrative away from unsustainable APYs sourced from tokens destined for diminishing value is a positive step. The future of DeFi hinges on creating sustainable products and services with genuine utility, earning tangible fees, and delivering real yields to the community. As we navigate this dynamic landscape, the pursuit of real yield stands as a guiding principle for a more robust and sustainable decentralized financial ecosystem!

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About us

Web3 Architects by Gotbit is a multidisciplinary team of over 150 blockchain analysts, protocol architects, token economists, and web3 venture experts. Since 2017, we’ve assisted more than 500 projects in designing tokens, modeling protocol economics and incentives, attracting users and liquidity, and securing investments from top funds. We’ve effectively guided hundreds of projects from token design to post-launch support.