Liquidity is one of the primary goals of any developed financial market. The problem is essentially, “I want to make X trade as cheaply as possible, and I need someone on the other side.” This applies not only to swapping tokens but also lending, borrowing, derivatives, and structured products.

For young DeFi projects liquidity is especially important. As they grow they want new users and stakeholders to enter through the market.

This article shows how DeFi solved this liquidity problem in the past and how projects like Fei, Ondo Finance, OlympusDAO, and Tokemak are solving it in the next wave of DeFi.

The big catalyst for DeFi was when Compound began issuing COMP tokens to suppliers and borrowers in their lending markets. This was the first “Liquidity Mining” — exchanging project ownership for temporary liquidity.

The problem is that liquidity mining is expensive and mercenary.

From the perspective of consumers, “yield farming” is the optimal strategy to move capital wherever it is paid the most in liquidity mining rewards. This creates a tendency for capital to leave as soon as rewards dry up, in addition to a slow bleeding effect when earned project tokens are continuously dumped onto the market as soon as they are earned. As we know, competition is great for consumers and hard for businesses (protocols). It also encourages innovation, which we’ll see later in the article.

Even with these high costs, it has never been easier to bootstrap a user base. Simply launch a token and give away 10–50% of it, and you suddenly have tens or hundreds of millions in TVL. DeFi summer in 2020 was the culmination of this wave, with innovations like pool 2 style farming leading to a cambrian explosion of new projects.

These numbers are not sustainable. Projects and investors alike are becoming increasingly aware of the harm liquidity mining does to the long term growth of a project, and are looking for solutions.

Solving these mercenary capital problems is part of the next wave of DeFi growth, recently referred to as DeFi 2.0. These new protocols are coming in higher up in the DeFi stack. They can use the scale and network effects of the base layer DeFi protocols to solve liquidity issues and attain greater market efficiency.

Instead of paying top dollar for mercenary liquidity, projects can instead either:

1. Buy their liquidity outright

2. Rent it from protocols that can offer the cheapest, highest quality liquidity

The former approach we call *Protocol Owned Liquidity *(or similarly, *Protocol Controlled Value or *or Protocol Controlled Assets). As examples, Fei Protocol, OlympusDAO, and Frax Finance are all powered by PCV, and as such their tokens have extremely high liquidity per unit of TVL.

The latter approach of renting liquidity we’ll call Liquidity as a Service (LaaS). LaaS can be highly efficient when offered by protocols that specialize in this service such as Fei and Tokemak.

Comparing New Approaches to Liquidity

Note: there are many ways to solve the mercenary capital issue including options and lockups. This post focuses on only a few approaches from popular projects

Olympus Pro is offering projects a chance to get their own Protocol Owned Liquidity by leveraging the OlympusDAO bond mechanism. Projects can exchange their token for any kind of LP token or underlying asset they wish, at a discounted price. This is a huge improvement over traditional liquidity mining programs where the project does not get to keep any of the mercenary liquidity.

The underlying token in Olympus Pro bonds does not need to have any relation to the OHM token, but projects can pair with OHM or sOHM to gain exposure to the OlympusDAO ecosystem.

Olympus Pro upends liquidity mining reward costs and shifts the burden on protocols toward more sustainable Protocol Owned Liquidity. Here, protocols can spend native tokens to acquire liquidity in perpetuity without fear of loss. Traditionally, liquidity mining represents the same high upfront cost with no benefit in return.

Projects that want liquidity but don’t need to own it outright can explore alternative ways to rent it than traditional liquidity mining programs, such as Tokemak and Fei.

One approach to Liquidity as a Service was introduced by Tokemak. Tokemak allows projects to provide a single token to a reactor, which is then paired with a base asset such as ETH, USDC, or (possibly in the future) FEI in liquidity pools. TOKE holders direct this liquidity towards the venues that need it most, and cover any impermanent loss that projects incur.

This impermanent loss coverage presents a great benefit to depositors. Tokemak accumulates assets for itself through trading fees. This ultimately reinforces its ability to provide sustainable liquidity. Initially, TOKE is emitted as a reward for users, and TOKE holders ultimately have a claim over the Tokemak Protocol Controlled Assets (PCA).

TOKE tokenomics encourage long-term value-aligned participation in the network. By acquiring a stake in TOKE, projects can direct their liquidity to whatever venues they need. This represents an upfront investment, but far better than traditional liquidity mining.

Projects looking for long term sustainable liquidity would do well to acquire a TOKE stake and seed a Tokemak reactor. They can use the TOKE to pair their project tokens in whichever supported liquidity markets they choose, without risk of impermanent loss. The Tokemak C.o.R.E.2 event voting begins on November 1.

Liquidity as a Service (LaaS) through Fei and Ondo

Fei Protocol supports FEI, a fully decentralized and scalable stablecoin backed by on-chain reserves. Fei can use its PCV to back liquidity provision denominated with FEI as a base pair.

Fei Protocol is partnering with Ondo Finance to offer a cost effective and flexible term liquidity as a service offering. Essentially, projects can deposit their project token into an Ondo liquidity vault with a flexible duration, and Fei Protocol will match their deposit with an equivalent amount of newly minted FEI to form a liquidity pair. The tokens get paired in an AMM such as Uniswap or SushiSwap

Fei Protocol essentially doubles any liquidity the project provides and removes all upfront capital costs. At the end of the vault window, the vault returns the FEI to Fei Protocol plus a small fixed fee, and returns all remaining tokens to the project.

The Ondo Vault takes care of all of the accounting behind the scenes, and the project is left with all trading fees AND all impermanent loss.

Fei Liquidity as a Service (LaaS) is a quick and cheap way to get USD denominated liquidity for a project.

Summary

Projects can now have their choice of investing in protocol owned liquidity through Olympus Pro, long-term value aligned liquidity through Tokemak, or cost effective Liquidity as a Service through Fei and Ondo.

These offerings are all a major improvement over traditional liquidity mining programs, and we expect new projects to move towards the offerings custom tailored to their needs at different stages in their growth.

Huge thank you to the Ondo, OlympusDAO and Tokemak teams for reviewing the article, as well as Brianna Montgomery, Storm Slivkoff, and Dan Elitzer for providing feedback!

Liquidity is one of the primary goals of any developed financial market. The problem is essentially, “I want to make X trade as cheaply as possible, and I need someone on the other side.” This applies not only to swapping tokens but also lending, borrowing, derivatives, and structured products.

For young DeFi projects liquidity is especially important. As they grow they want new users and stakeholders to enter through the market.

This article shows how DeFi solved this liquidity problem in the past and how projects like Fei, Ondo Finance, OlympusDAO, and Tokemak are solving it in the next wave of DeFi.

The big catalyst for DeFi was when Compound began issuing COMP tokens to suppliers and borrowers in their lending markets. This was the first “Liquidity Mining” — exchanging project ownership for temporary liquidity.

The problem is that liquidity mining is expensive and mercenary.

From the perspective of consumers, “yield farming” is the optimal strategy to move capital wherever it is paid the most in liquidity mining rewards. This creates a tendency for capital to leave as soon as rewards dry up, in addition to a slow bleeding effect when earned project tokens are continuously dumped onto the market as soon as they are earned. As we know, competition is great for consumers and hard for businesses (protocols). It also encourages innovation, which we’ll see later in the article.

Even with these high costs, it has never been easier to bootstrap a user base. Simply launch a token and give away 10–50% of it, and you suddenly have tens or hundreds of millions in TVL. DeFi summer in 2020 was the culmination of this wave, with innovations like pool 2 style farming leading to a cambrian explosion of new projects.

These numbers are not sustainable. Projects and investors alike are becoming increasingly aware of the harm liquidity mining does to the long term growth of a project, and are looking for solutions.

Solving these mercenary capital problems is part of the next wave of DeFi growth, recently referred to as DeFi 2.0. These new protocols are coming in higher up in the DeFi stack. They can use the scale and network effects of the base layer DeFi protocols to solve liquidity issues and attain greater market efficiency.

Instead of paying top dollar for mercenary liquidity, projects can instead either:

1. Buy their liquidity outright

2. Rent it from protocols that can offer the cheapest, highest quality liquidity

The former approach we call *Protocol Owned Liquidity *(or similarly, *Protocol Controlled Value or *or Protocol Controlled Assets). As examples, Fei Protocol, OlympusDAO, and Frax Finance are all powered by PCV, and as such their tokens have extremely high liquidity per unit of TVL.

The latter approach of renting liquidity we’ll call Liquidity as a Service (LaaS). LaaS can be highly efficient when offered by protocols that specialize in this service such as Fei and Tokemak.

Comparing New Approaches to Liquidity

Note: there are many ways to solve the mercenary capital issue including options and lockups. This post focuses on only a few approaches from popular projects

Olympus Pro is offering projects a chance to get their own Protocol Owned Liquidity by leveraging the OlympusDAO bond mechanism. Projects can exchange their token for any kind of LP token or underlying asset they wish, at a discounted price. This is a huge improvement over traditional liquidity mining programs where the project does not get to keep any of the mercenary liquidity.

The underlying token in Olympus Pro bonds does not need to have any relation to the OHM token, but projects can pair with OHM or sOHM to gain exposure to the OlympusDAO ecosystem.

Olympus Pro upends liquidity mining reward costs and shifts the burden on protocols toward more sustainable Protocol Owned Liquidity. Here, protocols can spend native tokens to acquire liquidity in perpetuity without fear of loss. Traditionally, liquidity mining represents the same high upfront cost with no benefit in return.

Projects that want liquidity but don’t need to own it outright can explore alternative ways to rent it than traditional liquidity mining programs, such as Tokemak and Fei.

One approach to Liquidity as a Service was introduced by Tokemak. Tokemak allows projects to provide a single token to a reactor, which is then paired with a base asset such as ETH, USDC, or (possibly in the future) FEI in liquidity pools. TOKE holders direct this liquidity towards the venues that need it most, and cover any impermanent loss that projects incur.

This impermanent loss coverage presents a great benefit to depositors. Tokemak accumulates assets for itself through trading fees. This ultimately reinforces its ability to provide sustainable liquidity. Initially, TOKE is emitted as a reward for users, and TOKE holders ultimately have a claim over the Tokemak Protocol Controlled Assets (PCA).

TOKE tokenomics encourage long-term value-aligned participation in the network. By acquiring a stake in TOKE, projects can direct their liquidity to whatever venues they need. This represents an upfront investment, but far better than traditional liquidity mining.

Projects looking for long term sustainable liquidity would do well to acquire a TOKE stake and seed a Tokemak reactor. They can use the TOKE to pair their project tokens in whichever supported liquidity markets they choose, without risk of impermanent loss. The Tokemak C.o.R.E.2 event voting begins on November 1.

Liquidity as a Service (LaaS) through Fei and Ondo

Fei Protocol supports FEI, a fully decentralized and scalable stablecoin backed by on-chain reserves. Fei can use its PCV to back liquidity provision denominated with FEI as a base pair.

Fei Protocol is partnering with Ondo Finance to offer a cost effective and flexible term liquidity as a service offering. Essentially, projects can deposit their project token into an Ondo liquidity vault with a flexible duration, and Fei Protocol will match their deposit with an equivalent amount of newly minted FEI to form a liquidity pair. The tokens get paired in an AMM such as Uniswap or SushiSwap

Fei Protocol essentially doubles any liquidity the project provides and removes all upfront capital costs. At the end of the vault window, the vault returns the FEI to Fei Protocol plus a small fixed fee, and returns all remaining tokens to the project.

The Ondo Vault takes care of all of the accounting behind the scenes, and the project is left with all trading fees AND all impermanent loss.

Fei Liquidity as a Service (LaaS) is a quick and cheap way to get USD denominated liquidity for a project.

Summary

Projects can now have their choice of investing in protocol owned liquidity through Olympus Pro, long-term value aligned liquidity through Tokemak, or cost effective Liquidity as a Service through Fei and Ondo.

These offerings are all a major improvement over traditional liquidity mining programs, and we expect new projects to move towards the offerings custom tailored to their needs at different stages in their growth.

Huge thank you to the Ondo, OlympusDAO and Tokemak teams for reviewing the article, as well as Brianna Montgomery, Storm Slivkoff, and Dan Elitzer for providing feedback!