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Liquidity mining rewards are broken, let’s fix this!
The design of many liquidity mining programs very extractive and parasitical, where projects are giving rewards in hopes of bootstrapping their liquidity, but the liquidity providers that farm either end up extracting and destroying project value.
The lifecycle of most DeFi projects tends to go something like this:
Launch protocol + token with certain price
Issue liquidity incentives in token with high APY
Apes add liquidity, TVL goes up, liquidity is solved (for now)
Token rewards are issued to the liquidity miners
Since its free money for them, they will sell at any price to lock in their APY gains
Token price goes down over time
Lower token price leads to lower APY
Liquidity decreases
Dumping continues
Project slowly fades into irrelevance
Some projects have tried to solve this with reward lockups, and other mechanisms, but it only delays the inevitable, which is based on a critical flaw of the incentive concept:
Mercenary traders will always sell to lock in profits
So instead of just giving tokens away for “free” - lets start establishing a cost basis for these tokens.
If instead of getting them for free, the liquidity miners need to pay something for them, this will raise the bar for what they consider to be “profit”.
For instance if they have paid $1 for a token, they will be more likely to sell them for greater than $1 instead of taking a loss. If they get them for free, any price over $0 is a profit for them.
Instead of just granting the tokens to the liquidity incentive scheme, protocols can instead grant token options as the reward for mining.
The protocol can set the “strike” price, or the price that the token can be purchased for, as well as the exercise window or expiration date.
Say a protocol’s token is trading at $10, they want to give rewards to liquidity providers, but only if they are adding value to the ecosystem, not extracting.
They decide to give liquidity incentives in the form of a token option, and they decide to set the strike price to $10, to incentivize value creation above the current state of the protocol. They want this to happen over the course of 1 year.
They can create an option token, where the underlying token is deposited and can purchased at a strike price of $10. The option token is earned just like any other token incentive, over time via staking.
Once the farmer earns the option token, they can choose to exercise it by paying the strike price of $10, before the expiration date of 1 year.
If the token price has gone up to $30 as a result of the value added to the ecosystem, they will gladly pay the $10 to get rewarded with another $20 in value!
If the token price has gone down to $5 - well it seems that value was not added to the ecosystem and it is no longer worth participating.
With this model, the strike prices essentially create a floor beneath which the liquidity miners are not willing to sell at a loss, unless they fully lose faith in the project.
It also has the added benefit of bringing capital into the DAO treasury to be used for creating additional value in the ecosystem.
Valorem has launched their DeFi options primitive which makes it possible to easily (and cheaply) create a basic option contract as a token.
Head over to Valorem protocol to generate an option token for any ERC-20 token:
Liquidity mining rewards are broken, let’s fix this!
The design of many liquidity mining programs very extractive and parasitical, where projects are giving rewards in hopes of bootstrapping their liquidity, but the liquidity providers that farm either end up extracting and destroying project value.
The lifecycle of most DeFi projects tends to go something like this:
Launch protocol + token with certain price
Issue liquidity incentives in token with high APY
Apes add liquidity, TVL goes up, liquidity is solved (for now)
Token rewards are issued to the liquidity miners
Since its free money for them, they will sell at any price to lock in their APY gains
Token price goes down over time
Lower token price leads to lower APY
Liquidity decreases
Dumping continues
Project slowly fades into irrelevance
Some projects have tried to solve this with reward lockups, and other mechanisms, but it only delays the inevitable, which is based on a critical flaw of the incentive concept:
Mercenary traders will always sell to lock in profits
So instead of just giving tokens away for “free” - lets start establishing a cost basis for these tokens.
If instead of getting them for free, the liquidity miners need to pay something for them, this will raise the bar for what they consider to be “profit”.
For instance if they have paid $1 for a token, they will be more likely to sell them for greater than $1 instead of taking a loss. If they get them for free, any price over $0 is a profit for them.
Instead of just granting the tokens to the liquidity incentive scheme, protocols can instead grant token options as the reward for mining.
The protocol can set the “strike” price, or the price that the token can be purchased for, as well as the exercise window or expiration date.
Say a protocol’s token is trading at $10, they want to give rewards to liquidity providers, but only if they are adding value to the ecosystem, not extracting.
They decide to give liquidity incentives in the form of a token option, and they decide to set the strike price to $10, to incentivize value creation above the current state of the protocol. They want this to happen over the course of 1 year.
They can create an option token, where the underlying token is deposited and can purchased at a strike price of $10. The option token is earned just like any other token incentive, over time via staking.
Once the farmer earns the option token, they can choose to exercise it by paying the strike price of $10, before the expiration date of 1 year.
If the token price has gone up to $30 as a result of the value added to the ecosystem, they will gladly pay the $10 to get rewarded with another $20 in value!
If the token price has gone down to $5 - well it seems that value was not added to the ecosystem and it is no longer worth participating.
With this model, the strike prices essentially create a floor beneath which the liquidity miners are not willing to sell at a loss, unless they fully lose faith in the project.
It also has the added benefit of bringing capital into the DAO treasury to be used for creating additional value in the ecosystem.
Valorem has launched their DeFi options primitive which makes it possible to easily (and cheaply) create a basic option contract as a token.
Head over to Valorem protocol to generate an option token for any ERC-20 token:
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