One of the Old Adages of Investing goes something like:

“It’s not about timing the market, but time in the market.”

But being down -90% after diamond-handing those bags, how true is that really?

Let’s find out if you’d actually made the right choice in thinking your bags were long term holds.

Just a heads up: This article is for educational purposes only, and does not constitute financial or survival advice. The authors probably own a fair number of tickers mentioned in this article. Views are our own and probs aren’t shared by our frens nor colleagues.

Survival analysis

It’s jokingly said that there are more tokens out there than users in this industry. While it’s hard to verify that claim, what we could do is look at the tokens that have managed to stay relevant in the spotlight through the recent years.

Let’s look at the Top 300 tokens by Market Cap on CoinMarketCap from April 13, 2025 compared to 4 years ago, April 18, 2021, and see what has changed.

For context, April 2021 was one of the local tops of that cycle, so anything in the Top 300 were the projects that were the most popular at the time (one can even say, the most promising and hyped projects at that time).

We can see that only 115 projects that were in the Top 300 back in April 2021 are still within the Top 300 today, which is a “survival rate” of less than 40%. We don’t mean that 185 of these tokens literally went to zero, but that they were washed out of the cultural zeitgeist.

We repeat the same analysis to only include the Top 100 MC tokens (above), and get a similar result, only 43% of tokens managed to stay in the Top 100 after 4 years. We might have expected tokens in the Top 100 to have more staying power, but turns out that isn’t the case.

To rule out the possibility that new stablecoins have claimed more spots in the Top 100, we note that there were 6 USD stables in April 18 2021, and 5 USD stables + 2 GOLD stables in April 13 2025, which is not a meaningful difference.

We were also interested in seeing whether chain tokens had more staying power than the average token.

This time we filter from the Top 100 MC list for tokens associated with their own chains (L1 and L2 tokens). We used only tokens that have live chains (i.e. can view their block explorer), and removed tokens that may have announced chains for the future but not live yet (e.g. Ondo, Ethena).

Similarly, around half of the Chain tokens that were in the Top 100 back in 2021 are still in the Top 100 today. This is perhaps a harsh truth for the builders in the space, since it’s a hard pill to swallow to dedicate years of your time to an ecosystem just to have the chain become irrelevant over time.

It seems like even the most promising projects of their time are more likely than not to fall out of the limelight in a few years.

Itty Bitty Coins and a Dom

Another interesting perspective is looking at OTHERS.D, which is the dominance of altcoins excluding the top 10 coins.

Over the last 4 years, OTHERS.D has ranged from 8-16%, and exhibiting a slight down trend. This means that the majority of growth has gone to the largest 10 tokens. This is perhaps unsurprising as BTC’s own dominance has been on a steady rally since mid-2021 (see below).

BTC is the Dommy Mommy that’s absolutely topping OTHERS.

Have any Chain tokens consistently outperformed BTC?

We charted dozens of L1 tokens against BTC on multi-year time frames, and the list of candidates is pretty short:

• ETH (although it’s down bad against BTC in recent years)

• BNB

• TRX

• SOL

• XRP

These coins occasionally have a jump against BTC when the bull run swings around but usually they just go sideways.

The observation here is these tokens are all within the Top 10 by MC, and that basically everything else has been crushed by Dommy Mommy BTC. We think these tokens all all have found some type of market fit and mindshare (we’re pretty sure XRP’s entire product is a normie mind virus). Since attention begets liquidity, these tokens have some potential to keep pace with BTC.

This doesn’t mean that your favorite shidcoin can’t meaningfully outperform BTC in a bull run, but it does mean that shidcoins are likely poor long term holds compared to BTC.

Unlimited Supply of Finite Supply tokens

Just because Murad tells you that a shidcoin has finite supply doesn’t mean it’s hard monies like BTC. In fact, there are thousands of finite supply tokens (memecoins) being created every day.

And it’s not just memecoins, but dozens of new chains launch every month whose seemingly no differentiation besides whom they are targeting as exit liquidity.

Wei Dai

@_weidai

There's no such thing as an "L1 premium", but there has been a "undifferentiated L2 discount".

L2s inherit distribution & mindshare of their base layers, for better and for worse.

For a chain or an app, it's a balance of:
- Distribution
- Costs (dev, node infra, gas)
- Security

david phelps

@divine_economy

lots of apps and rollups are pivoting to L1s right now because they think there’s an “L1 premium” for the token.

this is not just grifter logic—it’s wrong.

they’re spending millions to bootstrap validators they can't even decentralize so they can enter a hype cycle at its end.

28

11:42 AM • Mar 28, 2025

So it’s not purely about hard supply caps, rather, it’s the social recognition that an asset is a store of value that makes it a store of value. Something something Keynesian Beauty Contest.

Fun fact, did you know that ETH is actually “harder” than Gold?

Ken Deeter (puntium.eth) 🦇🔊

@puntium

I did some more math. ETH has better economic SoV properties that gold.

Annual net supply increase is way lower (0.05% vs 1.34%)

Annual % consumed is higher (0.63% vs 0.16%)

ETH is already better than gold. The people just need to know.

810

12:22 PM • Apr 14, 2025

But because this narrative has already been won by BTC, we don’t see it become a Schelling point for another asset.

As a highly indebted man likes to say:

There is no second best.

What sets BTC apart from other L1s?

Bitcoin is the original appchain, with little value leaking out of its ecosystem. The vast majority of activity on BTC is simply miners producing blocks and users sending or receiving BTC, and this activity is unique to BTC. Bitcoin has also solidified itself as the premier PoW store of value chain. Whereas smart contract chains need to worry about a new high-performance L1 sapping away their users, and no serious traders are stacking Litecoin because it has cheaper + faster transactions.

All other chains are much more reliant on gas fees on other forms of revenue to survive. Smart contract chains in particular have positioned themselves as permissionless infrastructure that apps can then build on top of. However, this means that apps built on top are not completely aligned with the underlying chain. These apps can choose to extract value from users through fees and keep this value for themselves.

On top of this, the success of these apps is not directly tied to the success of a chain. Success of a chain isn’t what generates fees, users are. If users decide to migrate to another chain, it’s in an app’s best interest to be chain agnostic and serve users on whatever chain they’re on.

We’re far too aware that only Satoshi isn’t going around dumping that insider allocation on us, which makes a world of difference in price dynamics.

Chain Versus Apps

Let’s dig a little into the relative value capture at the Chain-level vs the App-level.

Above is a table of fees collected by various chains. As a premier smart contract chain, Ethereum unsurprisingly leads the way with $1.29b generated in fees over the past year.

Meanwhile, Ethereum DeFi powerhouses (above) such as ENA, LDO, AAVE, UNI, and SKY all raked in over $300m each in annual fees. The three Ethereum exclusive protocols on this list (ENA, LDO, and SKY) made a total of $1.6b in fees, $300m more in fees than Ethereum itself in the last year. This is a huge sum of money that is being awarded to these protocols and their users, and none of this money is obligated to support the underlying chain.

Additionally, Ethereum bleeds additional value through the existence of cheaper L2s, but admittedly L2s do return some value towards the ETH L1. One could argue this value is little on the chart, but we argue that the value is low at the moment because ETH is cheap to use at the moment. (Unfortunately, ETH the chain performs better as the price of ETH approaches 0.) If ETH sees a surge in activity and price in the future, ETH’s L2s will siphon a larger portion of fees away when gas gets expensive and users are further incentivized to perform cheaper transactions outside of ETH L1.

L1s are also fighting with each other to be the premier smart contract chain of choice. Various factors come into play (gas fees, transaction speeds, liquidity, yields). Users are understandably mercenary and will pick the chain that best suits their needs. With an assist from pumpdotfun, Solana has so far succeeded in becoming the memecoin chain of choice, siphoning away a lot of the revenue that memecoins once generated for ETH.

What can Milady do against such reckless FUD?

We took some time to think about how chains could do better to survive and prosper, and here are some ideas.

BTC backed chains

Instead of burning the gas fees collected by the chain, the gas fees could be swapped into a strong Reserve Asset, such as BTC. The BTC backing per gas token continuously goes up with time, and the chain basically becomes MicroStrategy.

A variant is to take the gas fees collected and deploy it into a GAS/BTC LP on the chain (in the same style as MakerDAO’s buyback-and-make).

BTC is just used as an example here, one could go with any other asset, such as USD stablecoins, tokenized gold, or (Heavens forbid) ETH.

Enshrined Apps on Day 1

Since smart contract chains have two major shortcomings, one is being dependent on Apps to generate fees, and two being the Apps are better at capturing value than the chain. To flip the script, new smart contract chains should launch with a solid enshrined app on Day 1. The best example is probably Hyperliquid launching the Perp DEX as an enshrined app on the Hyperliquid chain.

Native Yields

This route is for chains that put all the funds on the chain to earn yield, and the chain is able to take a cut of the yield produced as its own revenue. To a chain, this is more scalable than relying on gas fees. We have another article to go over this in extensive detail.

Sometimes due to a multitude of reasons, existing chains find themselves unable to make the push to transition to a Native Yield Chain. But there are interesting setups with projects like Agora’s AUSD or M0’s M stablecoins where the yield of the stablecoin is first shared with the chain operator, who can then decide the quantity and method to pass down the yield to the application layer.

Growth Engine Tokenomics

Some newer generation chains are experimenting with their core tokenomics because they recognize the disconnect between apps and chains.

Sonic’s Fee Monetization encourages applications to deploy on Sonic since apps can receive 90% of the gas paid by the users. However, this value flowing to the apps comes at the expense that the value that could have gone to the S token. This system also becomes less useful as chains are in a race to compete fees down to zero.

Initia’s Vested Interest Program gives additional esINIT rewards to app(chains) have manage to attract the most INIT tokens into them, acting as utility and token sinks for INIT. This doesn’t directly help the Initia protocol capture the value of the apps, but INIT token holders likely will be able to use their INIT productively (i.e. earn yield) through the various apps. One downside is that besides ETH, the native gas token is usually not a highly useful form of liquidity for applications, so we might end up seeing applications preferring to spend their own incentives to attract stablecoin liquidity over INIT.

Berachain’s Proof of Liquidity allows applications to submit bribes to the validators of the chain to direct BGT emissions to the users of the apps. This allows Berachain to receive some of the value generated by apps. A double-edged sword here is that applications are almost always going to get more emissions than their bribes, which allows the apps to supercharge their incentives, but Berachain almost always emits more value than it gets in return. Outside of an Enshrined App Chain like Hyperliquid, this is probably the closest we’ve gotten in terms of the chain partaking in the value created by the apps.

However, it’s worth noting that none of the above would be as direct as enforcing a direct revenue split with the apps (e.g. through an off-chain legal agreement), but such a chain hasn’t been born yet.

Conclusion

Tokens Bad, Bitcoin Gud.

Selling shidcoins is Smart, Diamond-handing shidcoins is Dumb.

Tokens sometime go up cuz we tell stories to each other about them going up.

Chains don’t have nearly as much value accrual as we’d like.

Perhaps we’d fix that someday.

🔛🔝🔜

I like hard assets and I cannot lie.

We’ve all seen our fair share of tokens with price charts that go down only. Most of that is vapourware evaporating, sure, but it also happens to legit projects that have poorly designed incentive mechanisms.

It’s common for a project to reserve a sizeable chunk of the token supply to reward stakers or lockers, or have an uncapped token supply with tail inflation to make sure the protocol can pay for things like validators or liquidity mining or voting participation.

The challenge facing us is, how we can incentivize users with meaningful rewards, while not over-inflating the token to death.

The answer is that perhaps we should allow projects to mint secondary tokens, each designed for a specific purpose.

For an industry that loves tokenizing things, we’re surprisingly conservative when introducing new tokens into the mix.

Just a heads up: This article is for educational purposes only, and does not constitute financial or magical advice. The authors may have positions in some of the tickers mentioned within.

Tokens as Access Rights

Most platforms with a token have some use case associated with the token (those without a true use case call it “Governance”). Although on many platforms we can see the same token be used to grant the holders access to multiple features at the same time, such as the governance voting, revenue share, directing emissions, paying for platform fees, etc.

Tokenized Voting Power

“1 token, 1 vote”, that’s how it works in most Proof of Stake systems.

DeFi protocols realized that voting has to be restricted so that only the most aligned parties are eligible to vote, the best examples are the “veTokens” that require you to lock your tokens in a vote-escrow contract for 1-4 years and you are granted “Voting power” in return.

Curve is the OG Pioneer of veTokenomics, and when you lock CRV, you get tokenized voting power in the form of veCRV. The longer you commit to locking, the more veCRV is granted to you. With veCRV, you’re eligible to participate in governance, direct future CRV emissions to pools, and receive a share of Curve’s revenue.

So CRV is the primary token here, and is mostly a “useless” token (other than for speculation), while veCRV is the secondary token that is used for governance and revenue share that the primary token cannot access.

For better or for worse, liquid wrappers often pop up, and those basically make the primary and secondary tokens fungible again. A more straightforward design would bypass the need for locks and liquid wrappers and give tokenized and liquid veCRV to CRV stakers.

Newer Generation veTokens

Two newer generation designs I like are Shadow’s xSHADOW and Berachain’s BGT.

With Shadow, the dex is emitting the secondary token, xSHADOW, to incentivize liquidity (as opposed to Curve emitting the primary token, CRV). xSHADOW requires time to vest into SHADOW, which delays the sell pressure coming from the emissions. xSHADOW also has all the voting rights and revenue share rights of the platform, which makes it more appealing to hold instead of sell.

With Berachain, the chain emits a secondary token, BGT, to incentivize the users of apps. BGT can be burned to obtain BERA 1:1, but the conversion is irreversible. BGT has all the rights associated with boosting validators and claiming bribes, which makes BGT appealing to hold instead of sell.

Berachain is also interesting because Proof of Liquidity can direct BGT emissions to arbitrary ERC20 token holders, and we could issue secondary tokens to users who perform a “desirable” action on our platform, and the secondary tokens could be a prime choice for BGT emissions.

However, note that with veTokens, the liquid vs illiquid (primary vs secondary) tokens are still largely “fungible”. There may be conditions associated with the conversion, but the tokens can still be converted with each other (esp. if there are liquid wrappers that facilitate the conversions). The secondary tokens are also not typical “consumed” after use, i.e. veCRV doesn’t disappear after you cast a round of votes.

Getting creative

We can allow users to stake their primary token and receive the tokenized Rights separately.

For a dex, it might look like:

• Token A to represent the right to vote on normal governance proposals

• Token B to represent the right to direct emissions

• Token C to represent the right to receive dividends

Markets can form around these secondary tokens, and price discovery can happen independently for each. We might expect token A to be largely valueless (until someone proposes to raid the treasury), token B to be purchased by other DeFi projects looking to incentivize liquidity, and token C to act basically like a cashflow token (not dissimilar to a Pendle YT). Token A might not be such a great idea since we generally don’t want governance votes to be easily bought, so we might consider giving the governance voting power back to the primary token.

Or, instead of allowing users to stake the primary token and always get all 3 secondary tokens, we could create 3 separate staking contracts, one for each secondary token. That way, users have to choose which tokenized right they wish to earn with the primary token.

Other possibilities are up to the platform, e.g. if we are a launchpad, we can have multiple tokens representing the rights to participate in upcoming sales (daos.world on Base has this mechanism).

Points rewards and Tokenized Airdrops

A familiar example to all farmers out there.

Most points programs are like an uncapped supply of future airdrop claims. You can emit as many of the claims as you’d like, and you don’t have to change the final amount of airdrop tokens.

This is really useful since you may not know which activities users are likely to participate in to earn the points, and you can always adjust the points periodically to get the distribution you want.

I think it’s cleaner if you tokenize the “points” and make them liquid and fungible. But at that point, you should drop your actual token already.

One thing to note that’s different here from the veToken examples above, is that generally speaking, to claim your airdrops, you have to “consume” your Points. Or, put differently, the Points are single-use.

Tokenized Monetary Policy

Inverse Finance is a really cool example of a lending protocol that tokenized the borrower’s interest rate. INV is the primary token of Inverse, responsible for governance voting. DOLA is the over-collateralized stablecoin (the “product”). And DBR is the secondary token that’s consumed (i.e. burned) to pay for the access to DOLA.

In order to borrow (mint) one DOLA from Inverse for a year, you must burn one DBR (DOLA Borrowing Right) token. If one DBR costs 5 cents to acquire, then the protocol is charging 5% to anyone trying to borrow DOLA.

Looking at the historical price chart of DBR above, we can see DBR has clear trends in rises and falls. Note that even though new DBR is minted and emitted all the time, DBR never falls to zero as there is always going to be a low enough price to entice a new borrower to step in and buy DBR.

If we were inverse and we wanted to fix the borrowing rate, we could simply create a flat bonding curve (i.e. 1 DBR is always purchasable for a set amount of USD). We can get even more creative and have bonding curve logic that’s dynamically adjusting to the supply of DOLA or peg of DOLA.

To illustrate its power, above is a hypothetical bonding curve for how Inverse could price the DBR on a bonding curve. While DOLA’s peg is stable, the price of DBR is low, and outside of an acceptable peg range, the cost of DBR rapidly rises.

The key thing to note here is that we don’t have to price DBR according to another token, we’re now pricing DBR to an arbitrary metric (i.e. peg stability).

In Inverse’s system, market actors are able to directly influence the monetary policy of DOLA by buying or selling the DBR token:

• Rate speculators could directly trade the borrow rates (i.e. buying DBR low and trying to sell it higher).

• The smart borrower could scoop up DBR whenever it’s “cheap” and store them to use at a later time when DBR might be “expensive”.

• Inverse itself could mint and distribute DBR to use to give to INV stakers, to give as liquidity mining rewards, or to lower the borrow rate by selling on the market.

Even if we flood the market with an over-supply of DBR, the “worst” outcome is that the cost to borrow DOLA has just been lowered and users are *more* incentivized to borrow on Inverse due to the lower rates.

When designed well, an oversupply of the secondary token doesn’t lead to the primary token being rekt, instead, it should lead to more usage of the platform.

Tokenized Blockspace, a.k.a Creating a PoS network out of a finite supply token

Let’s look at Neo, a.k.a. The Chinese Ethereum, as an example here. NEO is the primary token of Neo Network and NEO is responsible for governance. Holders of NEO automatically get a secondary token called GAS in their wallet, which is used to pay for, wait for it, gas on the chain.

Below are the historical price charts of NEO and GAS, with Y-axis in log scale to smooth out the pumps.

A few observations. The most surprising one of all should be that despite GAS being inflationary and emitted every block since Genesis, GAS has not spiralled to zero yet. The “floor price” of Gas has held up well and almost seems to be creeping upwards over the years. We can also see that GAS can have vertical candles that go up 10x that crash back later.

You might argue this is not all that different from being able to stake some ETH and then using the ETH staking rewards to pay for txns on Ethereum. I agree. But with two tokens, we can get creative about how the secondary GAS token works. Perhaps GAS could emitted to NEO holders non-linearly (a square root function would encourage smaller NEO holders to use the chain more, while an exponential function would give most of the GAS to NEO whales).

Additionally, the protocol may set aside minting rights to the GAS token for its own use. Using GAS as for ecosystem incentives/grants may not be a bad idea, as the worst case outcome is that users that receive GAS would be encouraged to use the chain more (or sell the GAS, which makes GAS cheaper for all users to acquire).

Neo itself only does simple emissions of GAS, but we could imagine using bonding curves to price GAS, perhaps relative to the fullness of recent blocks in an EIP-1559 fashion.

There are a few more two-token chains, such as Ontology’s ONT vs ONG, Theta’s THETA vs TFUEL, and VeChain’s VET vs VeThor. The gas token is always consumed when users perform txns, but depending on the chain, the gas may or may not be placed back into circulation (by letting validators earn the gas fees).

Fun Ideas to Explore

There are a lot of teams building rollups on top of different L1s. For a Bitcoin rollup, one way to stay Bitcoin-aligned is to allow BTC as the staking asset of the L2 to secure the network, but to pay for the validators, a new GAS token can be emitted by the rollup. In this example, validators are always incentivized to stay online, while not introducing a superfluous new governance token for the L2.

Similarly, an enshrined rollup to Ethereum could take on a secondary token as its own GAS while allowing ETH to be the only governance token of the rollup.

Community/NFT rollups

Many NFT collections have strong communities, and it might be possible to spin up a rollup secured by the staking NFTs, and just emit GAS to reward validators

Dissipating GAS

It would be blasphemous to try to put mechanisms such as a time decay on governance tokens, but it would be perfectly reasonable to put a decay on GAS. Example, we could say that unused GAS tokens decay by 50% every week.

For users not holding the chain token, then any GAS they hold would shrink towards zero over a handful of weeks.

For users holding/staking a set amount of the chain token, their GAS holding would max out at some point.

This makes it really hard for users to hoard gas, the idea is to encourage users to consume the GAS and use the network.

On the other hand, if too much GAS has been emitted by the protocol, the GAS supply also shrinks so that the market isn’t flooded with unlimited supply.

Tokenized fee waivers

Generalizing the tokenized monetary policy and blockspace, we see that we’re essentially tokenizing the payment to access a particular resource. So if we can identify the resource that a protocol is actually selling, we can wrap it in a token.

Example 1, if we’re building a token bridging platform, then the resource being offered is providing you liquidity on a different chain for a small fee. Then this network can emit fee waivers to incentivize users that provide liquidity, solvers, etc.

Example 2, if we’re building an advertising billboard, then the resource being offered is the right to display an ad for some time on the billboard for a fee. Then the platform can emit fee waivers to incentivize new advertisers.

The design space gets much larger when you consider that the fee waivers may be conditional.

CEXes and betting platforms will frequently have promotions that look like this: “Get $50 when you sign up as a new user to our gambling website, and place at least $1000 in bets within 7 days of signing up”.

The fee waivers could:

• Be (soul)bound to a single user/group

• Offer a discount rate from 0-100%

• Be first-come-first-serve with a limited supply of redemptions

• Have an expiry date

• Have trigger conditions that must be fulfilled

Fee waivers can be priced by the market pretty efficiently (as long as some entity can make use of them right away). Temporarily flooding the market with fee waivers also won’t tank the price for the primary token, but we can’t do this long term because everyone using our platform will be using fee waivers instead of paying the intended “full” price.

Conclusion

There is no one token to rule them all.

Most projects have multiple aspects that involve the token holders, such as governance, revenue sharing, paying fees on the platform, etc. And as projects start to expand into multiple verticals (e.g. Aave expanding from lending into minting a stablecoin, Hyperliquid expanding from a perp dex to a general smart contract chain), it might make even more sense to have multiple secondary tokens that are specifically built to work with the constraints and needs of each vertical.

Secondary tokens have a much broader design space compared to primary tokens, and can explore useful mechanisms such as unbounded supply, decay, expiration, conditional usage, consumed after usage.

If we run a social media campaign or an ecosystem grants program, it might be a much better idea to reward participants with GAS or fee waiver style of secondary tokens rather than primary tokens, since cheap secondary tokens encourage participation on the platform. The lack of governance participation in a lot of DAOs could probably be solved by rewarding active DAO participants with secondary tokens.

Note that I am not arguing for dropping new unrelated tokens left and right, rather, secondary tokens should be emitted by the protocol to users and/or primary token holders. A well-designed secondary token can be used for incentive programs without creating unnecessary sell pressure on the primary token. In fact, a well designed secondary token can generate revenue (through selling the token or collecting trading fees) that accrue back to the primary token.

Hard assets are dead, long live hard assets.

In a multichain world, assets would also be multichain (duh!). That means assets will have to be bridged around. When a bridge mints you a receipt token on your destination chain, that’s in fact just a receipt, the real token is still sitting locked (and idle) inside the bridge contract of the origin chain.

This is all fine and dandy, until one realizes…

“Wait, why are the assets just sitting in the bridge, when they could be put to use somewhere to earn some yields!”

Indeed, Proof of Stake assets such as ETH could be earning the staking rewards, and RWA-related assets like DAI could be earning from the DAI Savings Rate (DSR).

Just a heads up: This article is for educational purposes only, and does not constitute financial or traveling advice. I am a contributor to various DeFi projects, including Redacted DAO mentioned at the bottom.

The Idea

Okok hear me out.

Wot if we took the assets from the bridge, and like, put them to work?

What’s the opportunity size?

Arbitrum is the leading L2 solution on Ethereum in terms of TVL, and there’s a lot of assets that have been bridged to Arbitrum. Below we can see a breakdown of assets locked into just the native Arbitrum bridge. There’s 3.7B USD of ETH and close to 80M of DAI just sitting there.

Suppose ETH staking is 3% APR, that’s 3.7B x 3% = 111M USD of potential annual yield. Suppose DSR yield is 5% APR, that’s 80M x 5% = 4M USD of potential annual yield.

If we look at the Arbitrum sequencer revenue below, it annualizes to about 80M USD.

So if Arbitrum staked all the ETH inside the native bridge today for some yield, the annualized revenue of the chain would more than double(!!)

Now that size is size.

The Rise of Native Yield Chain

Welcome to NYC (Native Yield Chain, not the city)!

Some prominent examples of NYCs are Blast L2 and Berachain, where major assets bridged into the chain are generating revenue towards the chain. We can define “Native Yield” to describe the yield being produced natively by some asset and then imported into a chain.

Pacman | Blur + Blast

@PacmanBlur

This L2 would not only be useful for Blur, but all dapps. L2s are not just execution environments, but execution + liquidity environments. An L2 with native yield unlocks possibilities for the entire on-chain economy. Perps, dexes, lending, NFTs, and even SocialFi would benefit.

83

6:15 PM • Nov 20, 2023

Chains that adopt Native Yield can have an unprecedented amount of room for experimentation.

Native yields can be redirected to key infrastructure operators.

Some infra operators had traditionally not been not compensated/incentivized to operate, such as the Relayer in Ethereum block building, IBC relays in Cosmos, wallet providers, etc. While other infra providers traditionally charge a hefty cost to the blockchain to provide their services, such as DA layer, block explorers, RaaS providers, oracles, etc.

Point being, with Native Yield, if the rollup/appchain pulls in enough TVL, there will be enough yield to cover all these costs associated with the key infra.

Eliminating pay-per-transaction fee model.

One thing about current blockchain UX that I think we’ve been accustomed to, but is actually really annoying when you think about it, is having your wallet confirmation pop-up on every txn and you have to double check the gas fee to pay.

Suppose the Native Yield is high enough to cover the costs of the rollup (see the key infra operators in section above), then technically the rollup is free to charge for its blockspace however it wishes and still turn a profit.

Some under-explored transaction fee models could be:

• making gas completely free (but this invites annoying MEV spam)

• offering subscription packages to use the chain Netflix style (i.e. pay $10 a month and you can use it all you want)

• wholesale blockspace credits with tiered discounts (the more gas you buy all at once, the more discounts you receive), or

• tiered freemium txns where everyone gets a few free txns but you need to hold the governance token to unlock more free txns, etc.

These are just some alternative fee systems that would offer a better UX and abstract away some of the annoyances of interacting with blockchains, like deciding on how much gas to put or worrying about running out of gas to pay.

Almost an infinite design space we can play with here, but the Native Yield is crucial to ensure the costs of the rollup will actually be covered no matter what.

Scaling past transaction fees as a revenue source

Blockchains usually make profits from selling blockspace. But between more chains opting to go down the “lower fees = better” route and more scaling solutions coming online, txn fees will drop by orders of magnitude. Another problem is a lot of useful apps do not require high frequency interactions, for example, if you use Aave as a passive savings account to earn some interest, you do not need to manage it more than a few times a year.

Native Yield allows the chain to monetize on its sticky liquidity rather than its usage, similar to charging an AUM fee from tradfi funds. One interesting note is that both txn fees and Native Yields will scale from the increased adoption of the chain, but the important part here is that Native Yield is orthogonal to txn fees and Native Yields aren’t limited by physics in how far they could scale.

Almost like magic!

Only Possible On NYC

Continuing on some of the ideas above, what would be some really cool apps that are Only Possible On NYC?

CSR and public goods

Suppose we run a NYC, and we create a unique Contract Secured Revenue (CSR) program. CSR was popularized by Canto to reward apps that drove a lot of gas consumption on their chain.

Suppose our version of CSR tracked both the gas usage and the amount of TVL contributing to Native Yield, and allocates rewards to protocols according to their contribution to both these metrics.

Then, we have solved monetization for the vast majority of apps out there:

• High txn count but low TVL protocols might be an NFT minting platform or a DEX aggregator

• Low txn count but high TVL protocols might be lending protocols or yield vaults.

• High txn count and high TVL protocols might be spot DEXes.

To remain competitive, many of these apps have been reducing fees or keeping fees at zero, which is a bad thing if the team still wants to put food on the table or drive value accrual to their tokens. If deploying on a NYC helps them monetize even if protocol fees are at zero, then it’s a no-brainer for them to at least try deploying on these chains.

(I can’t think of a low txn count and low TVL that’s useful but lemme know if you think of one lmeow)

Positive-sum Derivatives

Suppose we’re operating a derivatives DEX, having Native Yield means that between me and my counterparty, the pot of monies we’re fighting over is constantly growing larger, so we’re not playing a zero-sum (or negative-sum) game anymore. Also, the DEX might even consider using Native Yield to charge zero (or even negative) maker fees and taker fees. That’ll make trading on here more attractive and competitive than CEXes.

Perpetual and Autonomous Games

Suppose we’re building a Metaverse game, we can use Native Yield to first pay for the costs of the chain, and move away from the pay per txn model. Then, excess yields can be used to do cool things like prizes for tournaments, allowing the game to acquire PoL for its own assets, etc. Most games involving tokenized resources also find it difficult to maintain a floor value on them due to heavy inflation, Native Yields could serve as the source of buying pressure to counteract death spiral tendencies. We could also emit Native Yields to power autonomous agents, NPCs, or even enemies(!), as a way for the game world to evolve and improve over time.

Food 4 Thot

In general, having more value brought into a chain means there’s more monies to play around with. And more monies means you can cover costs, spend on incentives, and even bring value accrual back to your own token and ecosystem.

Here are a few analogies that may or may not help:

• Native Yield is like subscriptions, it’s generated consistently with time.

• Native Yield is like AUM fees, it scales with the value brought into the system.

• Native Yield is like taxes, it taxes the productivity of the underlying asset.

For those trying to maximize Native Yield, I think this formula will present a bit of clarity:

Native Yield = Time x TVL x APR

Does Native Yield have to exist on a rollup or appchain?

Not at all! Ethereum L1 is a NYC as well! One just has to capture that yield with LSTs and a few more tricks. We can see Balancer is tapping into Native Yields as a way to build a spot DEX that moves away from relying on swap fees for revenue into one that diversifies into using Native Yield as revenue:

Balancer

@Balancer

From LVR mitigation to Boosted Pools & Composable Stableswaps, Balancer V2 set the stage for efficient yield-bearing liquidity.

Now, with a Yield-Native Vault, Hooks, and 100% Boosted Pools, Balancer V3 is the Yield-Bearing Endgame.

medium.com/balancer-proto…

144

8:03 AM • Feb 8, 2024

Don’t the Native Yields Come With Risks?

Of course! We’re not quite there with a “Risk Free Rate” of DeFi yet, although ETH staking and battle tested bluechips like Maker’s DSR come close.

There will always be a space for chains that take the most conservative and risk-averse routes to setting up their chain, and perhaps integrating Native Yield directly into the bridge is not a risk they would want to take. However, it’s still possible to bridge Native Yield assets like ETH LSTs and sDAI to your chain, but in those cases, the yields accrue directly to the users and there is no way for the chain to capture that for its own usage.

Furthermore, I am of the opinion that as a general purpose rollup, you cannot convince builders to come build on your chain just because you’ve got the best tech. Yes, builders will still deploy to your rollup if you have a potential token airdrop. But no, the long-term builder’s decision will be whether they can make a successful and profitable product on your chain.

Additionally, here’s a thread from Knower on chains competing on the hyper-financialization front rather than competing on the ETH-alignment front:

knower

@knowerofmarkets

Some thoughts on L2s with and without native yield:

I was originally a pretty vocal skeptic of Blast, mainly because I felt annoyed with their marketing and was disappointed that they'd released without an actual product. It's still a multisig with almost $1.5b in TVL, but my

213

11:23 PM • Feb 6, 2024

Yields are dead. Long Live Native Yields

What’s Next?

A lil’ birdie told me that ████ia and ██st will be launching this year with some exciting Native Yield mechanisms.

If you’re building an app that could benefit from deploying on a Native Yield Chain, hit me up because I have some recommendations for you.

If you’re building an appchain/rollup/RaaS, Redacted’s Pirex ETH is the highest yielding ETH LST on the market and is ready to power your chain.

Keep your eyes on this space, NYC has a lot to offer <3

Just a heads up: This article is for educational purposes only, and does not constitute financial or dam construction advice. We probably hold some of the tokens mentioned here.

From our previous article, we suggested that looking at liquidity profiles across various chains and how they change over time. We’ve found that some ETH L2s have improving liquidity conditions even through the bear market.

Using an analogy, chains are like lakes and bridges are like rivers that enable assets to flow back and forth. Yield opportunities act like gravity that pulls asset flow in one direction or another. In essence, we aim to find the rivers where the flow is strong and we can build a dam to capture a portion of the flow.

Now, how do we capitalize on this flow of value? Do we just spray and pray at bridging projects?

Let’s first take a step back. We could look for the assets with the largest flows and see if there are any dams on top that’s harvesting the flow.

As long as you’re not a full “ETH Mainnet” maxi, you’ll probably find it reasonable to expect a lot of volume trying to bridge across various chains as crypto users speculate or access their favorite dapps.

Assumption #1 - we won’t live in a mono-chain world.

If this one is wrong, there won’t be a need for dams, and you may skip this article.

Stablecoins

USDC

Circle recently announced that USDC will have its own built-in cross-chain transfer.

USDC will have trustless, near-instant, zero-fee, no slippage, etc transfers across all supported chains. And USDC is the stablecoin with the deepest dex liquidity on most chains, main exceptions being BUSD on BSC and USDT on Tron.

Below is a list of chains that support native mint/burn of USDC, and there are announcements to support more chains in 2023.

Source: Circle docs

Fraxferry

Fraxferry is Frax’s own cross-chain transfer solution.

The main feature is that there are no additional features besides moving FRAX back and forth, so there are fewer ways that this can be exploited by highly profitable traders. If we view FRAX as wrapped USDC, Fraxferry extends the reach of USDC liquidity to even more chains.

On the Fraxferry app we can see the list of currently connected chains.

If we ask for a quote, we see that there is only a fixed 5 FRAX fee for transfers.

To summarize, we have one centralized and one decentralized stablecoin, both with deep liquidity that have their own bridging solutions. This will likely mean that for anyone trying to bridge any other stables, they might have lower total fees if they simply swap into USDC or FRAX first, bridge, and then swap into their desired stable on the destination chain

Assumption #2 - stablecoins will not require 3rd party bridges.

Stablecoin flow is like a river running in a separate underground tunnel that we have no access to, so no, we cannot build dams here.

An “ideal” stablecoin is also one that flows freely with no resistance, compared to “non-ideal” stables that users pay fees to bridge around. Stablecoins that rely on fee-extracting third-party bridges are less competitive than stablecoins that have negligible bridging fees.

So besides stablecoins, that leads us to the coins and tokens native to each chain. And of course the largest coin to consider is BTC ETH.

ETH

One of the things that makes ETH stand out among its L1 peers is that not only is it the gas token on its own chain, it is also the gas token on numerous Layer 2 (L2) solutions. You might’ve heard of Arbitrum and Optimism.

Side note, even for L2s that have their own gas token, if they settle back to Mainnet, they still need ETH at some point. For example, Metis L2 users pay gas in METIS tokens but the Metis chain still needs to pay ETH to settle back to Mainnet.

To understand ETH bridging flows, we have to understand bridging solutions. We won’t cover all the bridges for their technical and security details here. Rather, let’s take a look at what types of flow happens on them.

Native ETH bridges

All L2s come with a “canonical bridge”, usually constructed by the L2 team. Canonical bridges usually have no fees nor slippage in either direction. With optimistic rollups, there is a 7-day delay for fraud challenges to occur. However, the 7-day window is kind of an arbitrary and heuristic number where we’d be highly confident that even in poor environments (chain halting/reverting), we’d still have time for honest actors to report any fraudulent L2 transactions.

As optimistic rollups mature and other fraud challenge mechanisms come online, the challenge window might shorten to mere hours or even minutes. The curious reader can read about why the challenge period is set to “7 days”  and what the minimum period could be: Polynya on optimistic rollups and Ed Felten on Optimizing Challenge Periods.

ZK-rollups typically have zero fee or slippage on canonical bridges with minimal delay time (ETH Foundation on ZK rollups).

Assumption #3 - Transfers between L1s and L2s will be free and fast for optimistic rollups and instant for ZK-rollups.

Across

Across has an interesting method for charging fees. It is based on a global utilization rate of ETH (how much ETH is being locked up in the 7-day bridging from L2s compared to total ETH in the LP pool).

Source: Across docs

Side note, one of the cool features of Across’s utilization rate means that at any time, bridging between any supported L2s will have the same fees.

As we can see, the LPers are earning dirt poor yield. On the flip side, this means that bridgeooors are paying very little costs to bridge.

We may ask ourselves why LPers are willing to take such low returns. We speculate it’d likely be parties who benefit from associated positive externalities, e.g. who benefits from cheap+fast bridging? L2 foundations, the bridge team, large whale holding L2 token, rollup maxi, etc. These entities are effectively altruists (not to be confused with effective altruists), and will drive down the costs and profit margins of bridges.

Now, for L2 to L2 bridging, you can always use the canonical bridges if you are shuffling around funds with size. But for smaller transfers, going directly between L2s is better UX because you bypass having to wait for funds to arrive on Mainnet first as well as paying the mainnet gas fees.

Assumption #4 - Bridging across (ha!) L2s will be cheap and fast and it’s a race to the bottom on fees

This is like having rivers in parallel between two lakes. If a dam is built on one river and has too much resistance, the other rivers with smaller/no dams will get more flow.

Across is essentially a public good with minimal value extraction, and that’s the reason we list it here. Bridges that extract fees will find it an up-hill battle against projects setup like a public good.

Alt-L1

For most alt-L1 tokens, you’re probably only going to hold them on that L1. e.g. if we’re holding SOL tokens, the place with the best yield/liquidity/utility/security for this asset is gonna be on Solana.

It’s possible that users would have demand to gain exposure to these assets on a different chain, which would mean some bridging volume, but users who are doing this for long term exposure would not bridge often, and synthetic assets offer an attractive alternative vehicle which depends on oracles as opposed to bridges.

Avalanche is an interesting case because of their focus on the Subnet architecture. In a future with many subnets, users would probably have to bridge assets around regularly.

Source: Avalanche docs

For now, there is no universal/canonical Subnet bridge, but we imajin that if Ava Labs builds one, they wouldn’t be charging any fees on it either.

IBC

Asset transfers between IBC-enabled chains rely on “relayers”. The important bit to note here is that anyone could run a relayer, and that relayers do not charge any fees on the assets transferred (and even pay out of pocket sometimes to cover the gas costs on both ends). You can read more about IBC relayers in this post and follow the discussions on incentivizing relayers here and here.

IBC pioneered the idea of interchain accounts, where you don’t need to actually bridge assets around for interoperability. For example, if we were to do cross-chain lending/borrowing, we could keep collateral on Chain A and borrow debt on Chain B. Chain A can query the amount of debt on Chain B, and if I fall below the liquidation threshold Chain then A can liquidate my collateral.

Ideas similar to interchain accounts are also seen on EVM DeFi like Aave V3 and Tapioca. Coincidentally or not, both of these lending protocols have plans for a native stablecoin that can be bridged/minted freely across their respective supported chains.

Assumption #5 - Cosmos dappchains (and cross-chain DeFi in general), they will have native bridging to minimize dependencies and costs imposed by 3rd party bridges.

CEXes

CEXes remain the best bridges to date. You transfer an asset on one network, you pay a fixed cost to withdraw the asset to a different network. If transferring large sums, the fixed costs are negligible. Sometimes you get hit with a delay or the exchange has to rebalance the assets across the chains. Whether you are personally willing to use CEXes or not, lots of big money bags will use CEXes as bridges.

Assumption #6 - If you accept some KYC and centralization, you get the biggest portal gun known to humanity and you are a god compared to pleb bridgeooors.

Conclusion and Predictions

Now this piece may read like it’s a bearish view on bridges, but it actually isn’t. We’re extremely bullish on the flow of value between chains going up and to the right. We’re just even more bullish that competition among smart teams will lead to very little barrier to the flow of value.

Bridging solutions will likely seek ways other than asset transfer fees to create and capture value. Some examples might be facilitating message passing for cross-chain dapps, cross-chain MEV, or even monetizing on the fact that the bridges get first access to observe large asset flows in real time.

Now for some fun ideas and predictions. For ETH bridges, the opportunity cost of being an LPer is the ETH staking rate. One way to overcome that cost would be using liquid staked ETH as the bridging asset. This concept works fine as long as there are liquid pools for liquid staked ETH on the destination chains. Liquid staked ETH holders would gain access to additional yield above vanilla staking by being a bridge LPer.

Not only can we use bridges to import and export assets, we can also import and export yield by having the token be a yield-bearing token. For example, we can have a yvDAI token representing 1 DAI deposited into Yearn’s DAI vault on Mainnet and the yvDAI accrues yield over time. If we bridge 1 yvDAI to another chain, we’ve exported yield in DAI to this other chain. The holder of yvDAI on the destination chain can access the yield either by bridging back to mainnet to withdraw for DAI, or if a liquidity pool exists on the destination chain, then just swap yvDAI for DAI directly.

Even though we dived into bridging concepts a bit here, we avoided all mentions of bridging tokenomics and investability. Mebbe that means a new article soon™?

Just a heads up: This post is just for education, and this post is not financial nor criminological advice. We may hold tokens of some of the projects mentioned here.

After a certain effective altruist tested the solvency of several major CEXes and on-chain ecosystems, we have decided to do (yet another) a follow up and assess the damage to the ecosystems of our favourite digital currencies.

Methodology

We followed the same methods as our last article. Market caps were pulled from CoinGecko. TVL was pulled from DefiLlama. The DEXes used to determine slippage were DEX aggregators where possible (like 1inch, Kyberswap, and Jup.ag), or the largest DEX on a chain when aggregators were not present. All numbers were pulled on Dec 18, 2022.

We checked the slippage when selling tokens that fit into the categories of: primary gas token (gas token of the chain), secondary gas token (gas token of the underlying L1), and governance token of the chain. We examined a total of 17 chains and 24 chain-token combinations.

We attempt to sell the token in question for the most liquid stablecoin on the same chain.

Using the data, we asked the following Qs:

• What happens when you try to dump 1% of the Market Cap on chain

• What happens when you try to dump 1% of the TVL on chain

• How much dumping will bring slippage up to 50% (we’re calling this metric “Exit Liquidity”)

• Chains were then assigned an “illiquid factor”, which was calculated by dividing TVL by the amount of money required to reach 50% slippage. A really high illiquid factor means that even if a tiny fraction of TVL decided to exit, they would cause terrible slippage and also take away a large fraction of stablecoin liquidity. The naïve interpretation is that high illiquidity factors are bad.

What we are essentially asking is: Of all the liquidity actively participating in DeFi, how much of them can exit back into stables below a 50% slippage?

Changes from the previous article: inclusion of the OP token on Optimistic L2, using USDC(axelar) as the most liquid stablecoin on Osmosis, inclusion of Firebird dex aggregator.

For full data, see link to GSheets here.

Observations

Instead of going over the entire spreadsheet, we will highlight a few curiosities that caught our attention.

Dex aggregators

Initially, we wanted to take a closer look at the two leading L2’s for Ethereum, Arbitrum vs Optimism. In the first version of the draft, we found that the max size we could route for 50% slippage (“Exit liquidity”) on both Arbitrum and Optimism was 20,000 ETH using 1inch.

Intuition says that Arbitrum should have a lot more liquidity than Optimism, so what happened? Let’s dig deeper.

We saw that Optimism routing is more complex, mostly routing through the Synthetix ecosystem.

On Arbitrum, the main liquidity source for large swap remains to be GMX, however, as soon as we ask for a quote larger than what GMX supports, 1inch defaults to a single source. The slippage is extremely low when under the GMX max limit, but suddenly spikes when above that limit.

We can see that 1inch is not routing optimally for the 20,000 ETH quote on Arbitrum, since you could first fill whatever the GMX max limit is, then fill the remaining using other dexes.

We decided to test a few more dex aggregators.

For large swaps, Kyber is just defaulting to whatever 1inch returns. Honestly, that’s kinda smart/lazy. Well played.

Funnily enough, the aggregator that got it right is a little-known one called Firebird:

FIrebird was able to figure out if you hit the max on GMX, it can use other dexes.

Digging further, we got comparable quotes from Firebird and 1inch on Avalanche, but the two use quite different routing.

However, Firebird does not get better results on Optimism, where 1inch routed 20K ETH for 50% slippage but firebird had 85% slippage on the same quote.

Due to this incidental finding, in this published version, we updated our article and spreadsheet to use firebird results on Arbitrum and Avalanche.

A note for any highly profitable traders, it’s dangerous to assume that by using a dex aggregator you are getting the best routes! Be aware that aggregators might have chain-specific strengths and limitations when swapping in size.

Tron vs BSC

At publication time, BSC and Tron have very similar TVL levels, which makes a comparison of their illiquid factor even more interesting. BSC’s got a much lower illiquid factor than Tron. After drinking two spiked eggnogs, our interpretation of this is that people are more willing to buy shidcoins on BSC than shidcoins on Tron.

Osmosis

Axelar’s bridged USDC is now the dominant stablecoin TVL, replacing UST. Side note, Osmosis’s quote system breaks when the slippage approaches 30-40%.

Stablecoins

On the vast majority of chains, USDC gets the lowest slippage when swapping in size. Exceptions are BUSD on BSC, USDT on Tron, xDAI on GnosisChain.

This indicates a strong trend that USDC is the dominating stablecoin for liquidity on-chain.

Ohh if only we could get our paws on some of that sweet, sweet, Circle equity.

GMX and Synthetix

GMX could be said to be the main force in enabling large ETH trades with minimal slippage on Arbitrum, while Synthetix is doing the same on Optimism.

Questions have been raised regarding the long-term viability of allowing zero (or near zero) slippage spot trades (see GMX price manipulation attack). But to large spot traders, both GMX and Synthetix are a blessing.

We ask ourselves why GMX on Avalanche has not drastically improved the exit liquidity, perhaps, it is because the max swap limit of GMX for AVAX tokens has been capped due to potential price manipulation attacks. We speculate that if GMX continues to grow on Avalanche, it would lead to similar spot liquidity improvements as seen on Arbitrum.

Perhaps smaller chains/ecos would look at this and quickly conclude they must launch their own GMX/SNX fork. We’ve seen numerous forks of GMX and SNX attempted, with none gaining significant traction close to the OGs.

Arbitrum and Optimism

On the topic of GMX and SNX, we can see that Arbitrum and Optimism are the only two chains that had an increase in Exit liquidity while all the other chains had decreases. ** **

While far from decisive, we’re gonna take this as a strong hint that the “L2 thesis” is the centipede while the “Alt-L1 thesis” is more of a worm.

Sorry, did we lose you on that metaphor? Let’s put it this way, which one’s got more legs?

Solana vs Near

We constructed the graph below, where the dotted orange line indicates a (hypothetical) linear relationship between “price” and “Exit liquidity”.

Despite both SOL and NEAR having >80% price drawdowns since May, NEAR doesn’t have nearly (ha!) as large of a drop in the “Exit liquidity” metric. In fact, NEAR seems to be an outlier for how much Exit liquidity there is! Our interpretation is that big money would be comfy buying Near at current prices or lower (through providing liquidity on dexes). 

Solana is absolutely rekt in terms of liquidity. We interpret this as a sign that people pulled their money out of Solana faster than SBF’s dad did to SBF’s mom.

A discovery

Finally, a sm0l discovery as a parting food for thought. There’s a decent linear correlation between TVL and Exit liquidity.

If we squint a bit, the formula for the line is pretty close to 0.023x=y, which means that in the average chain, each $100 of TVL is propped up by only $2.3 of Exit liquidity. More insidiously, we could say that a removal of $2.3 of Exit liquidity shaves off $100 in TVL.

Keeping in mind that when we say Exit liquidity we mean the amount required to cause 50% slippage in a spot trade, and that correlation is not causation.

Conclusion

Empires come and go, even the Ponzi Empires. Thank you for staying with us.

In the next edition of Fluff and Air, we have a new idea about which “types” of liquidity will matter most in DeFi. Please stay tuned <3

To help keep the lights on, we’ve enabled the Collection feature on Mirror!

As Jai aptly put in a his goodbye post to Tribe/Rari:

“...On-chain governance is overrated (should likely be structured as a liability more than an asset) and we should be pushing for complete immutability. DeFi has lost its way with tokens and governance.”

Using DeFi witchcraft, we have devised a few methods with which we can separate the price (and speculative value) away from the governance power of any token. In our opinion, this allows speculatooors to focus on speculating and the governooors to focus on governing.

While not directly related to the ideas presented below, we thoroughly enjoyed these two articles on examining crypto governance with a Roman Law lens (Part I and Part II).

Note: This post is not financial advice, and we may hold tokens mentioned here (yes, we know it’s Goblintown).

Idea #0 - Two forms of a token, one for governance and one for yield

A simple model would be to take one token and create two forms of it, and token holders could opt-in to one and only one form (tokens put into the “governance” form does not receive yield, and tokens put into “yield” form does not vote).

If a conversion method exists that allows the two forms to be interchanged, then both forms will likely converge on the same price. However, the incentive will likely lean in favour of holding the yield version of the token over the governance version. [see foot note at end]

While this isn’t a bad model, it doesn’t accomplish our goal of isolating price from governance power, and incentivizes token holders against holding the “governance” form of the token.

Idea #1 - Protocols lending out the tokens in their treasury

As an example, right now Aave is rewarding 1100 AAVE tokens daily to stakers, for an approximate 10% APR. But are they “over-rewarding” stakers?

Suppose Aave allows the AAVE tokens in its treasury to be borrowed, with say, a utilization curve that starts at 0% borrow APR when utilization is zero and maxes out at 30% borrow APR at full utilization. When the borrow rate is less than the staking rate, then there will be arbitrageurs who borrow AAVE to farm AAVE staking rewards. Overall, this will have the effect of bringing down the AAVE staking rate and bringing up the borrow rate. Effectively, the Aave treasury will be “taking back” the excess staking rewards that it is releasing to stakers.

One interesting thing to note is that the arbitrageurs in this case are not exposed to the price movement of AAVE (read: earning delta-neutral yield position that has governance power).

As a fun thought experiment, what if Aave were to launch today and all AAVE tokens are only accessible through borrowing? Then speculators would be deterred from holding AAVE as you need to pay borrow fees to access AAVE. Perhaps we also require borrowers to put down collateral in something that could benefit the protocol, maybe ETH, BTC, stables. So effectively, anyone who wants the staking rewards or the governance power must also provide liquidity to Aave. Effectively, this is like liquidity mining, but the protocol would pay *much less* than doing emissions straight-up to attract liquidity.

Enabling borrowing may be a controversial point, because borrowing also enables people to short sell the token, putting downward pressure on price. We will stipulate that a good enough project will eventually get listed on CEXes like Buy-nance and Effty-x, and the whale farmooors will use the CEXes to short the token into oblivion anyway. Also, when shorting is done through borrowing tokens from the treasury, then at least the treasury is making some income, but if the shorting is done through a CEX, then all the fees are going to that CEX and not the treasury.

On a serious note, enabling people to hedge is actually very important for price stability. If people can only go long or go home, then when the markets turn downwards everyone will be selling all at once, aka (-3,-3).

Voltz Protocol, Euler Finance, Rari Capital are examples of protocols that we think are doing cool things to enable permissionless lending markets as well as interest rate swaps.

Idea #2 - Governance Dollars

Continuing down the line of thought to create a delta neutral position while earning governance power, what if we hedged a spot position with a short perpetual position?

We can create “governance dollars” (we dub them Gov Dollars) by separating out the price from a token by hedging an equal amount using a short perp. Theoretically, we could create a unique Gov Dollar for every token out there.

This has several attractive features, the main one being, you can retain some governance power while holding a delta neutral position. Broadly speaking, short perps tend to have positive funding rates (longs pay shorts), which turns Gov Dollars into yield bearing stablecoins. If the underlying token also has some sort of yield (staking, revenue sharing, vote bribing), then the yield will hopefully offset any periods where perp funding turns negative.

The more Gov Dollars are minted, the more underlying tokens need to be locked away (lower circulating supply = boolish for price?). When the token price moves, the long and short need to be rebalanced so the short doesn’t get liquidated. Ideally, the staked token itself is used as collateral on the perpetual platform so liquidation doesn’t occur.

If periodic rebalancing of the long and short is enabled, then when the underlying token goes up, the Gov Dollar gets less voting rights. The reverse is also true, if the underlying price goes down, the Gov Dollar gets more voting rights. This usually works in our favour as most gov tokens are down only. We’d love to see the day where tokenomics are fixed so that Gov Dollars don’t make it beyond the cradle of ideas.

Note: we could also create Gov Dollars that do not rebalance. This will lead to a constant amount of underlying tokens (and thus voting power) per Gov Dollar.

With rebalancing, we accumulate more votes per Gov Dollar when the price of the token goes down. Without rebalancing, our number of votes are fixed per Gov Dollar. It would be possible for both forms to exist side by side.

Viewed in a different light, Gov Dollars are simply UXD-style stablecoins which combine a spot long with a perp short while retaining governance power. Then, we can create Uni V3 or Curve pools between your Gov Dollars of choice and any stablecoin for efficient swaps.

A few examples and thought experiments to illustrate potential benefits of Gov Dollars.

Using SUSHI as an example, let's hold some xSUSHI and short an equal amount of SUSHI to create Sushi Gov Dollars. If SUSHI price was to double, it would have no effect on the value of our governance dollars. However, xSUSHI earns yield in the form of SUSHI, SUSHI price doubling leads to our yield being doubled as well.

Governance dollars allow a way for people to speculate on governance power in a protocol, separated from price. If SUSHI continues to go up, the amount of SUSHI backing each SUSHI governance dollar gets lower, diluting your voting power. Conversely, if SUSHI goes down in price, then the amount of SUSHI backing each governance dollar increases, causing your voting power to go up.

Say a major hedge fund acquired a major chunk of a popular DEX, let’s call that Sashimi, but the fund also invested into an alt-L1 called Moona with a community of Moonatics. If MOONA blows up, then the hedge fund needs to sell their SASHIMI to remain solvent, thus crashing the price of SASHIMI. If we were Sashimi bag holders, then we'd be dragged into becoming community members by way of financial contagion from some other party that took too much risk and blew up.

Participating in governance should not expose the community to poor decisions made by other community members on matters unrelated to the project.

Say Sashimi has bad tokenomics and value accrual, and price action is down only. it might be possible to put forth proposals that have a good chance to turn Sashimi around. Wouldn’t it be better to participate in this governance decision without needing to take on the price risk?

Of course, reasonable counter-arguments are that gov dollars remove skin in the game, as well as potentially favour whales. Without rigorous proof, we’d like to counter that the retail (“community”) are usually the most vulnerable and sensitive to financial losses (compared to large funds and whales), and that by offering a method to participate in governance without risk of loss is actually more fair to retail.

Suppose the SASHIMI price keeps plummeting. If the market cap of SASHIMI is decreasing, our share of Gov Dollars will be increasing relative to the market cap, then we gain a larger proportion of votes. Suppose further that the market cap falls low enough that our gov dollars make up 50% of their voting power? Then we can use governance to take control.

Gov Dollars enable us to comfortably hold a project to zero. And at some point before zero, we might have accumulated enough governance power to put forth proposals to redirect the project.

The main significance of this idea is that if you want to participate in governance without being tied down to bad tokenomics or price volatility, you could do so.

As an exercise for the reader, what if we used short perps denominated in ETH? Could it be possible that we created “synthetic yield bearing ETH” tokens that hold governance power over your protocol of choice? Interdasting, wouldn’t you say?

Idea #3 - TimelessFi-style token splitting

Currently, most crypto protocols are single-token protocols. Governance and revenue are both rolled up into one token. We propose using a mechanism like in TimelessFi to split these singular tokens into PYTs and NYTs. You can read about how the PYTs and NYTs relate to each other on the TimelessFi blog.

To make a small modification on top of Timeless, the PYT portion would be used to accrue yield back to holders, and the NYT portion would be used for governance. To make the distinction, we will now call this PYT portion RevT (Revenue Token) and call this NYT portion GovT (Governance Token).

So a single underlying token deposited into this app would output 1 RevT and 1 GovT, and returning both 1 RevT and 1 GovT allows 1 underlying to be redeemed.And we can create liquid markets to freely convert the underlying, RevT, and GovT.

We predict that pure profit maxis would deposit the underlying and sell all GovT for more RevT, in order to maximize their yield. However, it would still be possible for GovT to gain yield if there are vote-bribing mechanisms in place.

Imajin a protocol that hands out liquidity mining rewards using RevT only, so that the liquidity miners don’t get governance, but the GovTs are airdropped as responsibility to users who fit other criteria. Since most liquidity is mercenary, we have avoided handing over governance power to mercenaries while still providing incentives.

If the protocol does token buybacks, then the protocol could choose to say, only buyback GovTs. If the protocol then burns 1 GovT, then 1 RevT can never be redeemed (effectively burned). We think that GovTs will be priced significantly lower than RevTs, so buyback-and-burn of GovTs should be much more capital efficient than buyback-and-burn the underlying. Magical innit?

You might be thinking now, “but the prices on GovTs are still not stable, you are exposed to the relative price movements between RevT and GovT, on top of the price movements of the underlying. I thought you wanted the tokens with governance to be stable so people can hold them with less risk?”

Glad you asked! Because we have composability on our side.

Composability is helluva drug

What if we combine ideas #1 and #2? We can create lending markets for governance dollars.

What if we combine ideas #1 and #3? We can create lending markets for govTs and RevTs.

What if we combine ideas #2 and #3? Well, there’s something cool here too.

By building PYTs and NYTs on top of governance dollars, this allows for an unusual form of leverage. You have a stable underlying, and can still separate out the RevT and GovT, with the condition that:

1 RevT + 1 GovT = 1 underlying = $1 USD worth of Gov Dollars

Conclusion

Now we have seen a few example methods that we can use to detach governance power from price (speculative potential) of a token.

We can also attach to the governance power portion to a token denominated in stables (or in ETH or anything else). Once the price volatility has been hedged out, there exists the new option to hold these Gov Dollars as a savings vehicle while being able to exercise voting power.

Splitting voting power from token price allows for increased methods of financial speculation. Also, any tricks applicable to stablecoins will also work on Gov Dollars, such as low slippage swapping (e.g. Curve, Uni V3, etc) and lending/leverage (e.g. Alchemix, Abracadabra, etc).

If you’re building out projects along these lines, please feel free to slide in our Twitter DMs.

Foot note

By the way, the ideas above seemed new to us, but upon some light research, we discovered that very similar ideas already existed in tradfi.

See threads here:

and here:

Alfa

@alfaketchum

Here's how the economic ownership and the voting power really look like.

2

11:53 AM • Apr 13, 2021

Just a heads up: This post is just for education, and this post is not financial nor astrological advice. We may hold tokens of some of the projects mentioned here.

After a certain illiquid algorithmic stablecoin that we covered in the previous piece exploded, we have decided to do a follow up and assess the damage to the ecosystems of our favourite digital currencies.

A little thought experiment about the Illiquid Factor

We gave a little bit more thought as to what the illiquid factor represented, and came up with a thought experiment to demonstrate it.

Scenario 1)

Suppose on a chain we have only one Uniswap V2 style AMM with a single ETH/USDC pool, and there is 1 ETH and 2000 USDC in the pool. The TVL of this pool is 4000 dollars (2000 USDC and 2000 dollars worth of ETH).

If you tried to spend 2000 USDC to buy ETH, x*y=k says you can get 0.5 ETH out, which is a 50% slippage.

So the illiquid factor is TVL/(amount to cause 50% slippage) = 4000/2000 = 2

Scenario 2)

Suppose we examine our pool which now has 0.5 ETH and 4000 USDC, the TVL is now 6000 dollars, and it would take a 4000 USDC buy order to cause 50% slippage.

The illiquid factor now is 6000/4000 = 1.5

So the illiquid factor goes down when there are more stables relative to the volatile token inside the AMM.

However, if one treated the TVL as not just the tokens locked into the AMM, but as all the assets on chain, then the scenarios would look as such:

Scenario 3)

Same setup as scenario 1, but we include the USDC that went into the swap as part of the TVL

TVL = (2000 USDC in AMM)+(2000 worth of ETH in AMM)+(2000 worth of ETH in wallet) = 6000

Slippage for 50% = 2000

Illiquid Factor = 6000/2000 = 3

Scenario 4)

Same setup as scenario 2, but we include the ETH that came out of the swap as part of the TVL

TVL = (4000 USDC in AMM)+(2000 worth of ETH in AMM)+(2000 worth of ETH in wallet) = 8000

Slippage for 50% = 4000

Illiquid Factor = 8000/4000 = 2

The point we wish to highlight here is that regardless of where one draws the boundaries for the definition of TVL, the illiquid factor correlates with the ratio of volatile token to stables inside the AMMs.

The TVL data we gathered from Defillama represents the funds that are actively participating in the DeFi ecosystem of all these chains, and probably is closer to scenarios 3 and 4 rather than scenarios 1 and 2.

It is our opinion that the illiquid factor represents some level of risk in participating in DeFi. For example, when a chain that has a high illiquid ratio, it means that a smaller proportion of funds would be able to get out with less than a 50% slippage.

We leave as an exercise to the reader of how adding or removing liquidity to the AMM affects the illiquid factor.

Methodology

We followed the same methods as our last article. Market caps were pulled from CoinGecko. TVL was pulled from DefiLlama. The DEXes used to determine slippage were DEX aggregators where possible (like 1inch, Kyberswap, and Jup.ag), or the largest DEX on a chain if not possible. 

All numbers were pulled between 5/15 and 5/16. We imagine the general ratios between MC and TVL will remain relatively stable, but the underlying data will quickly become stale as prices change.

We checked the slippage when selling tokens that fit into the categories of: primary gas token (gas token of the chain), secondary gas token (gas token of the underlying L1), and governance token of the chain. We examined a total of 17 chains and 23 chain-token combinations.

We attempt to sell the token in question for the most liquid stablecoin on the same chain.

Taking a similar approach to (link to thread), we asked the following Qs:

• What happens when you try to dump 1% of the Market Cap on chain

• What happens when you try to dump 1% of the TVL on chain

• How much dumping will bring slippage up to 50%

Chains were then assigned an “illiquid factor”, which was calculated by dividing TVL by the amount of money required to reach 50% slippage. A really high illiquid factor means that even if a tiny fraction of TVL decided to exit, they would cause terrible slippage and also take away a large fraction of stablecoin liquidity. The naïve interpretation is that high illiquidity factors are bad.

We did add a few more columns that allow us to compare how the illiquid factor changed from pre-crash to post-crash.

Observations

We will try to pick out a few interesting things that caught our intention.

We welcome the readers to dig into the full data here: On-chain Liquidity and Slippage Comparison - May 15 2022

We’d also like to refer the reader to the work and discussion surrounding similar analyses on Twitter:

Avi

@AviFelman

Surprising amount of sticky capital on BSC last week

112

12:50 PM • May 16, 2022

Ethereum

Ethereum drew down roughly 28%, but is only slightly less illiquid than before, with a small 3.5% illiquid factor increase.

Tron

Tron held up very well, likely because Justin Sun is essentially the chain personified. If His Excellency does not capitulate, then the price will not go down. His Excellency indeed did not capitulate, so the price did not go down. TRX drew down a mere 2%, and its illiquid factor actually improved by 3% post lunar explosion.

We take this as a sign that contrary to several YC startups, His Excellency’s farming funds are safu.

BSC/Sol/Matic/FTM

BSC, Solana, Matic, and FTM drew down 23%, 38%, 37%, and 56% respectively. However these four chains saw an increase in liquidity, their illiquid factors improved by 12%, 21%, 22%, and 11% respectively. This could be due to a wide variety of reasons. One possible reason is that the TVL of BSC, Solana, and Matic proved to be stickier than the rest.

BSC performed especially well, seeing less TVL drawdown than the rest while also holding its price against BTC quite well. A pessimistic explanation to this is that BSC shitcoins are so far removed from everything else in crypto and form such a large percentage of BSC TVL that a $40B asset can collapse and have extremely little effect on BSC shitcoin prices and the BSC TVL.

FTM on the other hand was absolutely obliterated. A possible explanation is that although FTM TVL got destroyed, the stablecoin liquidity of FTM was less affected. People removed less than the proportion of stablecoin liquidity in comparison to how much FTM went down in price.

Terra

Our sincere condolences. Goodbye Moonmen

On a serious note, suppose one wanted to manage risk through on-chain perps and hedging protocols. How effective would it be to purchase insurance when the payoffs are denominated in UST (not to mention the chain was halted and funds were not accessible)?

This highlights an argument that hedges against a chain failing cannot be placed within said chain.

Osmosis

In the previous piece, we looked at OSMO/UST. Obviously, this pool exploded. We also mentioned the fact that ATOM/OSMO was the most liquid pool on Osmosis - many users exited LUNA/UST through ATOM and OSMO. This caused prices of ATOM and OSMO to dump hard and ct_zpy’s familia will never recover from this loss.

A side note, a lot of liquidity providers in the LUNA and UST pools really got the short end of the stick because of the bonding unlock periods. We suppose the lack of hedging methods in IBC didn’t make things any better.

Near and Aurora

On Aurora, liquidity got better for the NEAR token and worse for the ETH token relative to the beginning of May. While on Near, the liquidity got worse for NEAR. We speculate that this indicated that the general opinion is leaning towards Aurora being a NEAR-centric ecosystem rather than ETH-centric.

Layer 2s

The ETH liquidity has actually improved on Arbitrum and Boba, while getting worse on Optimism and Metis. It was surprising that the liquidity of ETH was not sticky on Optimism and Metis, but at the same time went up for Boba. Maybe someone who knows someone who might know something.

On Arbitrum, we’d like to point out this: GMX was integrated into 1inch, and the max size you can push through is roughly 20K ETH or 40M USDC. The slippage on that is ~0.5%, For comparison, a 20K ETH swap to USDC would be roughly 2.5% slippage on Ethereum mainnet. This actually makes Arbitrum the singular best place right now for low slippage large ETH trades.

Concluding thoughts

The markets presented us with a unique opportunity to study the composition of liquidity on-chain from a very broad level. While something like the illiquid factor might be too broad to offer any specific actionable insight, we were able to examine some outliers of extreme improvements and deteriorations of liquidity across the various chains. Potentially, the illiquidity factor can serve as something like a “health indicator” for DeFi ecosystems.

We may do one more round of data collection on this series to study in a few weeks to see how the liquidity flows after the markets had more time in the post-crash recovery phase.

Just a heads up: This post is just for education, and this post is not financial nor nautical advice. We may hold tokens of some of the projects mentioned here.

Following the bricking that happened on Fantom and some of the analysis that followed, we wondered how liquid our favourite chains are?

Or put simply, if you were trying to exit the chain with *size*, how rekt would you (and the chain) be?

Spoiler alert - your chain is not that liquid.

Methodology

Market caps were pulled from CoinGecko. TVL was pulled from DefiLlama. The DEXes used to determine slippage were DEX aggregators where possible (like 1inch, Kyberswap, and Jup.ag), or the largest DEX on a chain if not possible. All numbers were pulled between 4/30 and 5/1. We imagine the general ratios between MC and TVL will remain relatively stable, but the underlying data will quickly become stale as prices change.

We checked the slippage when selling tokens that fit into the categories of: primary gas token (gas token of the chain), secondary gas token (gas token of the underlying L1), and governance token of the chain. We examined a total of 17 chains and 23 chain-token combinations.

We attempt to sell the token in question for the most liquid stablecoin on the same chain.

Taking a similar approach to (link to thread), we asked the following Qs:

• What happens when you try to dump 1% of the Market Cap on chain

• What happens when you try to dump 1% of the TVL on chain

• How much dumping will bring slippage up to 50%

Chains were then assigned an “illiquid factor”, which was calculated by dividing TVL by the amount of money required to reach 50% slippage. A really high illiquid factor means that even if a tiny fraction of TVL decided to exit, they would cause terrible slippage and also take away a large fraction of stablecoin liquidity. The naïve interpretation is that high illiquidity factors are bad.

Results

Here is our raw data table:

Here is a visualization of the relationship between the Illiquid Factor and TVL:

You can find a link to the spreadsheet here (and hopefully, we find a better alternative to G-Sheets in the future).

Overall trends

Using the “illiquid factor” metric, Ethereum is ranked 18th among the 23 combinations we looked at. However, the amount of money required to to reach 50% slippage on Ethereum is 1.18B, which is much higher than other chains. The closest chain is BNB with 430m required to reach 50% slippage.

Thus, our “illiquid factor” metric is an interesting, but flawed metric. As the largest chain, Ethereum is obviously the most liquid chain. Most chains are simply incapable of pushing 1.18B in a single transaction, and the few other chains that could would eat much more than 50% in slippage. Perhaps a better way to measure illiquidity would be to calculate the ratio of TVL that is alts vs stables.

Slippage when pushing 1% of TVL is an interesting way to see which chains have a variety of liquid assets. Osmosis and Metis rank at number 1 with 8%. It appears that OSMO/UST and METIS/ETH form a large % of TVL on their respective chains. ETH, SOL, and AVAX respectively have 48%, 37%, and 47%- suggesting that ETH/USDC, SOL/USDC, and AVAX/USDC make up a much smaller % of TVL on their respective chains.

Luna and UST and xDAI

xDAI is a neat case because the native gas token is also a stable coin. The main reason why the illiquid factor is very low because xDAI exists in a Curve pool with USDC, and there is actually negligible slippage until you have heavily skewed the pool ratio. In our opinion, this is an under-appreciated advantage of having a stablecoin gas token.

In comparison, even though UST is also a native gas token as well as a stable coin, there is no exit liquidity in the form of alternative stables (weUSDC is the best we could find) on Terra! A sizeable chunk of UST locked into Anchor as well as dexes across all the chains, and the main UST liquidity exists on Curve on ETH Mainnet.

Funnily enough, when you enter a big number into astroport.fi, it gives slippages of greater than 100%!

Knowing a lot of UST is either not on Terra or not liquid, it makes sense that Luna is illiquid on Terra as well. One caveat, we know that Luna can be burned to mint more UST, so in an emergency, some actors could choose to burn Luna and use UST to buy more Luna.

“Wait! Won’t people just add liquidity back on-chain?”

Maybe! But in a scenario where something catastrophic happens, the chain will be extremely congested, as everyone and their grandma who took out a collateralized loan is getting liquidated.

During this period, the token prices would likely be falling on CEXes, which will cause price feeds to provide lower prices and cause more bricking on-chain as more ppl are now under liquidation risk.

Osmosis

The most liquid pool on Osmosis is the ATOM/OSMO pool, unlike most chains where a stablecoin pool is their most liquid pool. The UST/OSMO pool currently has 222m in liquidity, whereas the ATOM/OSMO pool has 281m in liquidity. This makes the ATOM/OSMO pool about 27% more liquid. That being said, if the price of ATOM and OSMO continues to dump, the UST/OSMO pool will end up being more liquid.

Near

NEAR is more liquid on Aurora than natively on Near itself. We take this to be evidence that EVM-compatibility brings a lot of liquidity much faster than building a native DeFi ecosystem from scratch.

Layer 2s

Interestingly, ETH on all L2s (except Aurora) have better liquidity than on ETH Mainnet. This would mean that unless your size is actually size, you’d get more bang for your buck when converting ETH on a L2 instead of Mainnet.

AURORA is Aurora chain’s governance token, and doesn’t have much utility yet. AURORA on the Aurora chain is very illiquid. We might expect the same to happen when/if to other L2 governance-only tokens (looking at you, Optimism and Arbitrum).

In comparison, BOBA is actually very liquid, considering it is also just a gov token. We attribute this to the fact that Oolongswap on Boba actively incentivizes LPs for the BOBA/USDC pool, while the the incentives to LP AURORA/USDC is lower.

Not too surprisingly then, ETH on Boba and Aurora is much more liquid than the L2 gov tokens themselves (BOBA and AURORA).

What else can we do with this analysis?

• For a more comprehensive detailing of how much exit liquidity there is on-chain, we could calculate the % of TVL that belongs to volatile tokens vs stablecoins.

• With only a single time point in our dataset, it’s hard to interpret exactly what the implications are. So we could track the change in this ratio over time as a chain develops an ecosystem.

• We could also investigate the change in “illiquidity” around certain large events. Does the liquidity ratio improve in a bull or bear market? Or when an ecosystem implements various changes (EIPs, gov proposals, new tokenomics, etc).

• On-chain stop-loss hunting, guided by the total stable liquidity as a means to gauge where to trigger a liquidation cascade. Malevolent actors could use these metrics to guide their approach to bringing down the chains they don’t like.

This concludes the second edition of Fluff and Air. Meow~

Welcome to Fluff and Air, a brand new hopefully recurring publication by 0xcarnation and ct_zpy where we fud try to better understand your stablecoins. Meow.

Just a heads up: This post is just for education, and this post is not financial nor mathematical advice. We may hold tokens of some of the projects mentioned here.

Typically, stablecoins are cryptocurrency tokens pegged to the US Dollar. However, the main reason stablecoins are pegged to the USD is that the USD is the world’s reserve currency. As a result, the US Dollar is the best risk-off asset available and commonly used to denominate global trade. Thus, we should define a true stablecoin as assets where both the risk of loss and risk of gain are 0. However, it’s important to note that “stablecoins” we talk about are just tokens, which can trade at any price. The best solution we have so far is to come up with ways to peg them to the USD.

We will attempt to cover a range of stablecoins and build up some intuition and insight.

USDC and USDT

The most simple stablecoins are USDC and USDT. These two stables are backed by centralized companies. People trust that Circle and Tether have assets to back their coins up, and thus their coins maintain peg. You can read Circle’s latest attestation here, and Tether’s latest attestation here. According to these statements, both are fully backed.

As centralized stablecoins, USDC and USDT are not permissionless. Circle and Tether can decide to freeze the coins in your wallet at their discretion. However, this may not necessarily be a bad thing, as the Kucoin Hacker had their funds frozen by Circle. (Devs finally did something.) But this carries a major drawback: these centralized entities could receive political or legal pressure to freeze (blacklist) the funds of any individual.

Despite these caveats, one could argue that USDC and USDT are the strongest and most trusted stablecoins in the space.

Dai from MakerDAO

Dai is a tiny bit more advanced. Dai is a decentralized stablecoin minted through MakerDAO, and each Dai is over-collateralized by a mix of USDC and other strong crypto assets.

However, this over-collateralization means that Dai is not very capital efficient. More than $1 worth of assets backs each Dai, which is only worth $1. This excess collateral makes Dai safe, but sacrifices capital efficiency in return.

The mechanism for bringing DAI back to peg is two-fold. Let’s say Dai is trading above peg at $1.10, then you can swap 1 Dai for 1.10 of USDC, which you can use to mint more DAI to sell for more USDC.

When Dai is below peg, borrowers are incentivized to take advantage of the cheap Dai to repay their loans. If your debt is 100 Dai and Dai falls to $0.80, then you can buy 100 Dai for 80 USDC and close your loan at a 20% discount.

Hence, repaying debt is the use-case (and demand) for Dai.

Magic Internet Money from Abracadabra.money

MIM is quite similar to Dai. MIM is issued against an over-collateralized crypto position. Burrowers will either repay their MIM debt and receive their collateral back, or their collateral falls to debt value and Abracadabra liquidates the collateral to cover the debt.

An interesting food for thought is that for all MIM out there, there is a corresponding amount of debt that is slowly increasing in size. If everyone tries to repay their loan all at once, would there be a squeeze on MIM?

MIM also has a separate token, Spell. Spell can be locked and staked, allowing users to vote on governance and earn 75% of the interest fees generated by MIM.

Because MIM only allows stronger assets with larger market caps to be provided as collateral,  the chances of liquidation are significantly lower and MIM is quite safe. A riskier version of MIM exists in Mai.finance, which more or less works the same way that MIM does, except Mai allows users to borrow using riskier assets that MIM does not accept.

Similar to Dai, repaying debt is the use-case (and demand) for MIM and MAI.

Thus concludes the first release of Fluff and Air. We will begin fudding your stablecoins in the next release of Fluff and Air. Meow.

A crypto-economy needs diversity to flourish. I would like to describe several DeFi products we can build to add some new flavours into DeFi. I believe this suite of products as a whole can boost the health of the entire ecosystem that it resides on. I’m writing primarily with the Arbitrum ecosystem in mind, but the products and ideas are chain-agnostic.

What will you do to help usher in the Future of France, Anon?

Just a heads up: This post is building advice, if you think you can build or fork any of these, I’d love to talk with you. However, this post is not financial advice. I’m currently doing some paid work for Umami Finance, and I may hold some of the tokens mentioned in this article.

Money markets

Lending and borrowing is the cornerstone of DeFi, since it enables use cases such as saving, margin trading, leverage trading, etc. Without borrowing, the only things that’d be left in DeFi are just spot dexes.

Idea: We still don’t have many lending platforms on Arbitrum and Optimism. Useful protocols to fork would be Aave, Compound, Geist.

One thing I’ve noticed is the relatively thin liquidity of stablecoin pools on Arbitrum. I suspect that Arbitrum is primarily denominated in ETH, and there are few use cases for stablecoins. Once we introduce lending platforms, stablecoin volume should quickly ramp up, since borrowing stablecoins is the most popular way to get leverage. Also, if we ever want normies to come and “live” in the Arbitrum ecosystem, there must be better stablecoin yield so they can grow their “life savings” here.

Interest rate arbitrage

On most lending platforms, there are token incentives to deposit and to borrow. Sometimes we can “fold” our deposits by looping our deposits and borrowing against them multiple times, and earn extra tokens through each loop.

Intra-platform

Idea: Given an asset that can be both deposited and borrowed, we need to determine the optimal leverage required to generate max APY. We need to harvest the rewards periodically and compound our deposit. We also need to monitor the borrowing rate closely; if the rate rises and turns net APY negative, we should deleverage until we find a new optimal leverage. There is no liquidation risk (in theory), since we always use the same asset on both the deposit and borrow sides.

Inter-platform

Idea: Given two lending platforms that use the same asset, we need to determine if we can borrow at a low rate and deposit at a higher rate in a different platform. We might need to involve a second asset as collateral on the platform we are borrowing from. We might need to use flash-loans to unwind our positions when the borrowing rate becomes unfavourable. There is liquidation risk if the prices are volatile and chain becomes congested.

Leveraged Farming protocol

Allows depositors to deposit single assets and earn interest. Farmers can borrow two assets and LP them together and farm rewards. In general, there is more rewards with higher leverage, but only up to a point. See Impermax on Arbitrum and Tarot on Fantom.

Smart leverage monitor

Idea: Most applicable to leverage farming with pegged (or similar) assets pairs, like two stablecoins or two different wrapped versions of the same asset, so there is low/no risk of impermanent loss and liquidation. We need to monitor how much leverage produces optimal yield, and deleverage when the borrow rates are too high. We high even stop LP-ing all together and do single sided deposits if the deposit interests are favourable.

Farming as a Service

The most sustainable way to generate revenue is to provide a service for a fee. Yield management products are one of the most popular products in the DeFi space, as well as having sustainable revenue (see Beefy, Yearn).

Whoever controls the flow of token emission also shapes the flow of liquidity in the entire ecosystem.

Simple Autocompounder

• Example: Farm gOHM/ETH in Sushiswap, sell SUSHI rewards back into the gOHM/ETH pool

These are your "standard" autocompounders, not very interesting, and bad for health of ecosystem, since they generate constant sell pressure of the farm token.

Directed autocompounder

• Type 1 (LP -> single): Farm DPX/ETH on Dopex, keep DPX rewards and stake single-sided

• Type 2 (single -> LP): Single stake DPX, sell DPX rewards for staked DPX/ETH LP

• Type 3 (LP -> LP): Farm DPX/ETH on Dopex, sell DPX rewards for staked rDPX/ETH LP

• Type 4 (single -> single): Stake DPX, sell rewards for staked rDPX

Directed autocompounders are not common, Beluga on FTM is one of the few examples (uses Type 2 and 3). These autocompounders are very useful to users, because it allows for more customizability, and promotes risk diversification (we are compounding into new pools vs back into the same pool).

Idea: Type 1 (LP -> single) is benefits protocol token price the most, since we are nudging the default behaviour to encourage “staking” instead of “selling”. Skipping over Type 2/3/4 because these will be have to be customized for each possible use case.

Arbitrum Yield bearing Index

A weighted Arbitrum Yield Bearing Index. See Cook.finance on Avalanche for an example of “Avax Yield Bearing Index”.

An Arbitrum index might be composed of:

• Staked GMX

• Staked BADGER

• Staked JONES

• Staked MAGIC

• Staked DPX

• Staked UMAMI

• Etc

Idea: This benefits the health of the entire Arbitrum ecosystem, since overall we are encouraging staking over selling. This benefits users, as it is an easy way to buy into Arbitrum ecosystem, and gives exposure to purely yielding assets. This benefits projects in the ecosystem, as they could all be exposed to each other’s success by holding a portion of their treasury in this index, and incentivizing collaboration among protocols.

Idea: Index tokens are generally less volatile than any one individual token, and this is a desirable quality for a good collateral asset. So it’d be nice if we could borrow against this index token.

Idea: We can use the Directed Autocompounders to direct yield from LP farms into the Arbitrum Yield-bearing Index token. This allows investors to use only yield from any source to generate exposure to the entire Arbitrum ecosystem.

Idea (as well as a personal wish): we could have a portion of yield from index go towards an Arbitrum ecosystem development fund, public good funding (e.g. Gitcoin, Ethereum Foundation), subsidizing the gas fees for the entire rollup/chain, and/or profit-sharing back with the protocols in the index.

I’m in! What can I do?

My frens over at Umami would love to get some help in building out these pieces of infrastructure over on Arbitrum. Please join the discord and we can discuss how we can help each other. Possibilities include joining as a team member or paid contributor, and if you are launching, then we would love to talk about being early investors and bespoke partnerships.

If you are interested in building any of these on any other chains, we are experimenting with a community-run degen project incubator over at Aogiri Tree. We have a wide range of talent from thinkooors, buildooors, hustlooors, and most importantly, we’re all fun-loving sh!tpostooors. You can contact me on twitter and we will be spinning up a discord for discussions.

As we all know, it takes all types of skills and folks to produce a top quality product, so please don’t be shy even if you are not a dev.

Of course, you are totally welcome to take any of the ideas and build it out yourself! Competition adds flavour to life, and ultimately, the winners are the ecosystem and its users, and that’s what we are all about.

A secret, for those who made it to the end

A little known secret, is that this article only contains half the magic. The other half of the magic needs to come from you, dear reader! I just know that we would have a blast when our ideas collide! Come @ me on twitter. Would love to see it!

“All power tends to corrupt, and absolute power corrupts absolutely” - Lord Acton

Just a heads up: This post is just for education, and this post is not financial nor existential advice. I may hold tokens of some of the projects mentioned here. If you find yourself seeking world domination after reading this post, please contact me, because I think we may share similar goals (:

My deepest gratitude to @0x_kitsune, @0xindigo, and @0xSere for their patience and feedback after listening to me ramble about the ideas here.

TL;DR: Voting power is a weapon, and we should wield it carefully.

Power is forced while influence is voluntary, but if we gather enough influence, it is as good as power. I will be using the terms “power”, “influence”, and “voting” interchangeably.

We will use the Curve platform and its token, $CRV, as a case study into the important of voting power, and we will speculate on what this might mean for the future of DeFi.

Curve 101

Stable-swaps are a staple for DeFi, since we have many stablecoins (and pegged tokens). Curve’s AMM formula makes it suitable for stable swaps, because it allows for more liquidity when the price move in a narrow range.

As for why we have so many stablecoins in the first place? No one truly knows, but the market is saying there is a demand for multiple types (centralized vs decentralized, backed vs over-collateralized vs algorithmic).

The only important part to understand, for our purposes, is that different pools in Curve earn $CRV tokens, and $CRV token holders can vote on which pools get more or less $CRV rewards in the future (there’s a few steps to lock the tokens to get voting rights, but we’ll skip over that).

Imagine you’re a stablecoin whale, and you’re farming the $CRV token. Would you prefer a “valueless governance token” or “compound interest”? Of course rationality (read: greed) dictates you take value over valueless.

So there must be sufficient buying demand for the $CRV token, otherwise it becomes another farm token that gets dumped into the nether realms.

Why is $CRV desirable then?

For a stablecoin token to gain adoption, it needs to be “attractive” to use. Several attractive qualities include: Low slippage, high liquidity, high rewards.

In fact, all three qualities are tied together! When there is high $CRV rewards in a given Curve pool, whales and farmers are incentivized to LP here, which increases liquidity, which decreases slippage. Users and traders will quickly notice that certain stablecoins are better than others for all the above qualities, and this stablecoin will become rapidly adopted.

So we have the perfect Carrot and Stick setup. Controlling $CRV benefits a stablecoin, not controlling $CRV will hurt the stablecoin.

This means that $CRV is not a “valueless” governance token! And now, we have a way to price power. How much value would you place on becoming (and staying) the number 1 stablecoin?

Herein lies a chilling thought:

The stablecoin that dominates is not the most decentralized or has the best backing system, but the one that has the most influence.

Is veTOKEN accumulation end game?

Likely not! We have to remember that veTOKEN wars have only taken off since Convex launched in May 2021. And there are many methods of how projects can accumulate influence.

On the accumulation side, we have the Convex model, and we also have OHM-models, like Redacted, Lobis, and DiamondDAO. Their commonality is that they all seek to accumulate the veTOKENs in their treasuries and never let go.

I have also seen announcements for the development of voting power market places, from BribeProtocol and Rari fuse 2.0:

Jai Bhavnani

@Jai_Bhavnani

Everyone wants to earn money. There are three good ways to earn money with gov tokens: lending, staking and bribing.

What if we could combine these three things and develop a market rate of governance power?

20

2:00 PM • Jan 24, 2022

One thing that excites me is the announcement from Dopex saying that they will open options pools for vote gauges, which will allow you to generate yield from voting power. Since we can already use wealth to buy influence, now we have come full circle. Cue the perpetual motion (read: money) machine.

What types of things will become like $CRV?

Bridges are the first thing that come to my mind, as they are literally stable swaps but for the same token except cross-chain. If a stablecoin aims to have cross-chain dominance, they need to have high reward rates to incentivize high liquidity, low slippage. And stablecoins definitely do need to be cross-chain, because a stablecoin that cannot move around is a boring stablecoin.

You may have used or heard of several bridges, like Synapse, Allbridge, Multichain. But we may also extend the bridge analogy to liquidity hubs like Osmosis.

In fact, a useful mental model is that, when there are multiple pools of liquidity, we can add veTOKENomics to adjust the incentives for each pool, be it farm token rewards, fees, or other parameters.

So we can turn virtually any token into a veTOKEN, and all these veTOKENs become valuable “weapons” that other projects must seek out to stay competitive.

So under that umbrella of veTOKENs, we can fit spot dexes, derivative dexes, yield vaults, lending protocols, stablecoin issuers, etc. We also have tokens that govern other aspects of DeFi, such as $FXS to govern Frax issuance parameters and $TOKE to govern liquidity redirection of its deposits.

There seems to be a resurgence in governance innovations. Linearly weighted “One token, one vote” is probably not the best way to do things. However, I’m not an expert on this topic, so I’ll defer those interested to the writings of @ibansadowski, @0x_kitsune, and VB himself.

Food for thought

The below statements are not meant to be taken as truth. Please read these statements and question to which extent they may be true. I’d love to hear you tear these arguments to shreds.

1

“You need three types of power to control the world. One is influence. One is wealth. The third is… force.” – Ushiromiya George

These types of power act as checks and balances on each other in the real world. In the absence of “force” (physical violence, legal regulations), then wealth and influence become force. And wealth buys influence. Thus, wealth is all-powerful.

Should crypto become a place where wealthy equals mighty?

2

“No matter what your power is, no matter how strong your opponent, lose once and it’s over. That’s the kind of world that’s out there waiting for us. And once you lose, there’s no do-overs.” – Nagakura Imari

We may only get one chance to get the power distribution right. The future success (and doom) of many projects may depend on who is accumulating the most power now.

3

Power creates moat.

Power can be used to increase the barrier to entry to new projects. This is how legacy institutions are formed. Will institutions also form in DeFi? If so, what should they look like? Who should control them?

4

“Those with power, fear us! Those without power, seek us!” – Lelouch Lamperouge

We may scoff at the ridiculous amounts of “national security” budget of large nations, but doesn’t that just tell us that to a nation, having total domination is priceless?

So for the projects and VCs that are accumulating veTOKENs like crazy, is that actually the most rational action after all?

5

“I was dead until the moment I met you. I was a powerless corpse pretending to be alive. Living without power, without the ability to change my course, was akin to a slow death.” – Lelouch Lamperouge

Why do nations try to increase arms? Is it because the most heavily armed nation wields an advantage over others, even if they choose not to exercise their power?

For entities like Convex, which controls the majority of $CRV votes, will they act more out of their self-interest like a nation? Or more like a “neutral” third-party like the United Nations Peacekeepers?

Or perhaps, they are closer to arms-dealers.

6

Is it profitable to invest in arms-dealers?

Do the nations of the world tend to increase or decrease the sizes of their armamentaria? Also, see the defence companies stock indices (e.g. SPSIAD).

7

Is it ethical to invest in arms dealers? Is it ethical not to invest in arms dealers?

Yes, personally, I think we should, because as long as we participate in the governance of these organizations, we can shape how they develop. It is my hope that we would be able to see those with the most power act as peacekeepers rather than warlords.

A secret, for those who made it to the end

A little known secret, is that this article only contains half the magic. The other half of the magic needs to come from you, dear reader! I just know that we would have a blast when our ideas collide! Come @ me on twitter. Would love to see it!

Just a heads up: This post is just for education. This post is not financial nor life advice, although it’s pretty solid in the author’s biased opinion.

Performance depends on life stability

Here’s the take home message of the article right off the bat.

Never become a forced seller.

This is important when you don’t have a lot of financial cushioning. Your performance in the market is not isolated from your life. Life has a way to slap you with unexpected expenses, and you might have to liquidate your assets at the most inopportune times.

Here are a few thoughts of mine on how to stabilize one’s life.

Stable savings

One dollar saved is greater than one dollar earned

Eventually, money is meant to be spent. But the longer you can suppress your living costs, the faster you can build your net worth. Zero judgment if you wanna buy a Rolex to flex though.

When in doubt, ask yourself, “would I rather buy this now, or retire earlier.”

A popular crypto investor trope is surviving on only ramen noodles. But do that long enough, and you’ll gonna end up with malnutrition. So instead of telling that you that the best ramen is the “Samyang 2x Spicy Hot Chicken Flavour Ramen”, here’s a link to some cheap foods with better nutritional content:

Cheap Foods to Buy if You're Broke or on a Budget

Need to slash your food spending and stay healthy? Consider these affordable and nutritious staples.

https://money.usnews.com

But since this isn’t a food blog, my point is that researching creative ways to cut costs in life should be considered a “profitable” activity.

Stable income for living expenses

We all have recurring expenses to pay, and it’d be a shame to have to sell our bags at losses just to pay bills.

Thankfully, it has never been easier to earn a good yield on stablecoins in DeFi.

Below is an example calculation with Anchor Protocol’s relatively stable (hehe) ~20% APY. I’ll just mention that there might be higher yield strategies such as one-sided LP-ing (e.g. Impermax Finance), or recursively borrowing and depositing (“folding”) on a money market app (e.g. aUST folding on Abracadabra, or using an autocompounder like YieldYak on Benqi).

First thing in a budget is knowing roughly what your expenses are. Easiest way is to just look at your credit/debit card summary for the past few months. If those details are hard to access, just add up the usual big expenses: rent/mortgage, car/gas, groceries, utilities, phone/internet, insurance, student loans, child support, boobahub subscription, etc

Let’s say my expenses come to $2000 per month (24K per year), and I want to pay it exclusively through yield from Anchor:

(Monthly budget) x 12 = (Amount Required in Anchor Protocol) x 20%

Let’s rearrange the terms using high-school algebra:

(Monthly budget) x 5 x 12 = (Amount Required in Anchor Protocol)

Crunching the numbers and we get:

$2,000 x 5 x 12 = $120,000

This means, if I put $120K of stablecoins into Anchor, then each month I would receive enough yield to cover my expenses.

Note: having enough yield for living expenses is the definition of “retirement”.

Contrast the above against the traditional financial advice on retirement. Tradfi would recommend saving up $600K dollars to earn a conservative 4% APY, and I would be able to afford the same $24K annual budget lifestyle.

A few questions to ponder, Anon:

• Is retirement a lot closer than you thought?

• How much do you need to be able to live on and retire in comfort?

• Have you already made enough to retire but haven’t cashed out yet?

If you’re not ready/able/willing to fully cash out yet, consider the following plan. Set aside enough funds to cover expenses for 6 months, and putting that into Anchor. In case the market becomes Goblin Town, you will always have some runway to figure things out.

Or perhaps you find fully cashing out too painful and worry you’d FOMO back into the market, then consider taking a small fraction (say 10%) of all future profits into a stablecoin stack. Then over time, you will build up a stable stack.

And if you think being in stables is weak, consider @DegenSpartan, one of the best investors of our generation. The man goes to bed COMFY each night, knowing that every second he spends dreaming of a hentai starring ScarJo, his stack grows bigger.

Just food for thought (NFA!), one can make DegenSpartan proud by cashing out 50% in stables and going 2x leverage LP farming on the other 50%. One would end up with roughly the same market exposure, less downside, and higher capital efficiency.

Working a stable job

If you have a job/gig that provides enough stable income to sustain living expenses, this will also help you endure tough market conditions.

Another point to consider is that, we are all accustomed to hearing 100x gains in 6 months stories, but few of us will achieve that. If we put things into perspective, stablecoin yield in DeFi has a much better Risk/Reward ratio than your tradfi market-wide index fund. Even if you just worked a normie job and the only crypto you touch is stablecoins, in the long term, you will still end up outperforming 95% of Wall Street Hedgies and 99% of normies.

A secret, for those who made it to the end

A little known secret, is that this article only contains half the magic. The other half of the magic needs to come from you, dear reader! I just know that we would have a blast when our ideas collide!

Just a heads up: This post is just for education, and this post is not financial nor traveling advice. Data and information were gathered from CoinMarketCap, Shrimpy.io, and Beethoven-x. However, this is not sponsored post.

Narrative waves

The crypto market seems to be chaotic and turbulent at a first glance. Piercing the surface of the market, you’ll find that the game revolves around shifting narratives and psyops warfare. For bonus reading material on market dynamics, I would highly recommend A very degenerate thesis by @knowerofmarkets, as well as The Game of Deception by Josh McGruff.

Or as aptly summarized by @bigd_intern:

little d kohai

@bigd_intern

i swear all of crypto is like 200 people just rugging retail over and over

it’s like a casino with an endless supply of fish flowing through

7

6:32 PM • Dec 9, 2021

Ideally, we want to formulate a plan that could take advantage of these narrative waves, and without us having to be trading savants or on-chain detectives.

The Rebalancooor

Ahhh I’m rebalancing!

Let’s imagine we are in the following scenario, it’s late December 2020. We are gathered with la familia for the holidays. We have not invested in crypto, yet we keep hearing “crypto” pop up around the dinner table. Apparently, there are rumours that a bull run is about to start. We make our New Years Resolution to put $5K into crypto and see how it goes. We’d like to think of ourselves as a tad more sophisticated than the average investor, and we know that portfolio rebalancing is a suitable strategy for capturing the average stock market returns. Could we apply rebalancing to crypto with similar success?

The key to catching all the waves is to be simultaneous in all the places.

To take advantage of the waves and pumps, let us construct a portfolio rebalancing strategy. We will be allocating a total of $5000 into a portfolio containing 10 coins, each weighted at 10% of the portfolio. As the prices move up and down, the weights will shift. We can set our rebalance threshold at 10%, meaning we will sell a coin is it becomes 11% or more of our portfolio, and buy a coin if it becomes 9% or less of the portfolio. The numbers in bold are parameters that can be modified, but in the following scenarios, we keep them the same to make things comparable.

The idea behind rebalancing is that we rotate our profits from tokens that have gone up into tokens that have gone down.

Our benchmark

First things first, let us define a benchmark to measure our performance against.

From the period between JAN 1st to DEC 1st, 2021. The total crypto market cap did a 3.5x. Just as a reference, BTC did a 2x, while ETH did a 6.3x.

A “good” strategy should track or outperform the total crypto market cap. A “bad” strategy will underperform the total crypto market cap.

Large cap portfolio

Let’s say we chose our portfolio by taking the top 10 coins by market cap in JAN 2021. I’m using the backtesting tool from Shrimpy.io to generate the data below.

If we look on the rightmost panel, we can see the tokens in our portfolio and their weights. The chart on the left tracks the performance of the Rebalancing strategy (red) versus HODL-ing the tokens without rebalancing (grey). The middle panel shows us the final performance on the end date of DEC 1st, 2021.

Observation: Looking at the chart, Rebalancing tracks HODL closely, but HODL takes a slight lead. The final performance of Rebalancing and HODL both beat our benchmark of 3.5x by a little bit.

Why did Rebalancing lose to HODL?

The reason seems to be that we rebalanced into several coins that did not recover their highs after the May crash (LTC, LINK, XLM, XRP).

Large cap with a little twist

Let’s say instead of going with the top 10 crypto, we picked just the top 9 and added Solana (a little cherrypicking here, but I do have a point to make). Luckily for us, Solana had one of the biggest gains seen in the crypto market this year.

Observation: Looking at the chart, we wee that HODL and Rebalancing were pretty close up until August. Starting September, Rebalancing severely underperformed HODL. And at endpoint, Rebalancing is close to a 2x to the total market cap benchmark, and HODL is close to a 5x to the total market cap. We can consider the difference between Rebalancing and HODL to be the impermanent loss.

Insight: If our portfolio contains a big “winner”, then (in hindsight) the optimal strategy would be to HODL, because we do not want to sell the “winner” to buy the “losers”. But even if we rebalanced, having just one “winner” lifts up the entire portfolio’s performance.

DeFi bluechips portfolio

Let’s say we assumed after DeFi Summer 2020, many of the DeFi tokens will make a come back in 2021, so we added some DeFi bluechips to our portfolio. Unfortunately, DeFi bluechips did not have the best price performance in 2021.

Observation: Looking at the chart, Rebalancing started to outperform HODL early on, and the gap widens throughout the year. At endpoint, HODL is at 0.75x of our market cap benchmark, while Rebalancing is at 0.92x of benchmark.

Insight: Even though we didn’t get any big “winners” in our portfolio, rebalancing has worked in our favour.

Why did the gap between rebalancing and HODL widen?

The likely explanation was that the DeFi tokens are all highly correlated with each other, and any price differences between the DeFi tokens tend to revert back to the mean. Rebalances are very good at capturing these temporary differences (the quants gave it a fancier name, statistical arbitrage or “stat arb”). Another way to see it is simply that DeFi tokens are highly correlated assets so they have lower impermanent loss.

Synthetic TriCrypto

Let’s say we want to be extremely conservative with our crypto exposure. We can copy the weights of Curve’s tricrypto token: equal exposure to BTC, ETH, and a stablecoin.

Observation: Looking at the chart, HODL and rebalance are pretty close in the first half of the year, and HODL steadily rises above rebalancing in the second half of the year. At endpoint, HODL is at 0.6x of our market cap benchmark, while rebalancing is at 0.47x of benchmark. Unfortunately, rebalancing underperformed even the BTC maxi portfolio (100% BTC HODL).

Insight: a tricrypto-style rebalancing portfolio is a “bad” idea in a bull market. Likely reason is that it has too much uninvested cash, and the rebalancing makes it sell the BTC and ETH too early. On the flip side, I’d imagine tricrypto-style to be hit the least hard in a bear market, but we will see how that pans out.

Some thoughts

Rebalancing is passive, conservative, and makes few assumptions about the market. Rebalancing means we will not show up on the trader leaderboards for the biggest gains, but it will also prevent us from showing up under biggest losses.

Rebalancing gives us a narrower range of outcomes, centred around the average market returns. And with lower uncertainty, we can make better plans around the other parts of our portfolio.

What percentage of the portfolio should be in rebalancing? While NFA, I’d personally lean heavier on the heavier side. I have full confidence that if we zoom out to yearly candles, the crypto market cap will be diagonally up to the right. Having constant exposure to the market (even when the bear hits, because losses are impermanent) is my attempt to capture the most upside passively.

Even if you are trader, you may want to keep a passive, lower risk portfolio separate from the active trading portfolio. Dedicating a portion of the trading profits to DCA into a rebalancing portfolio may be an interesting alternative to keeping the gains all in cash.

If our portfolio is well diversified and mostly large caps, rebalancing should give a close approximation of general market returns. This could be useful at the start of a bull run, as we have a good chance of outperforming the overall crypto market cap, BTC maxi, and tricrypto.

If our portfolio contains more “low-cap, high-risk gems”, rebalancing might be a bad idea. These portfolios are similar to early stage VC funds, where the general advice is to hold (or even double-down) on the winners, instead of selling winners to buy losers.

If our portfolio is concentrated in one sector, rebalancing should beat HODL thanks to capturing the “stat arb” opportunities as they arise.

Knowing all these facts and quirks about the performance of rebalancing, we may conceive of more complex meta-portfolios. For example, we could group tokens by their sector, and only rebalance within each sector. We could also put our low-cap bets in a separate basket that is not rebalanced. Of course, we could also introduce machine learning and other data sources to optimize our portfolio parameters, but the general principles don’t change.

DeFi portfolio rebalancing

Centralized solutions to portfolio rebalancing carry several costs, including spread and trading fees on an exchange, not owning our tokens, and 3rd party portfolio management software fees (unless you rebalance manually yourself).

An exciting future for portfolio management lies in DeFi, where we can join a pool, receive trading fees, own our tokens, and collect token rewards. So, pretty much the cons under CeFi become pros under DeFi. A few names if you want to look dig in further: Beethoven-x (more below), IndexCoop, BasketDAO, Cook Finance.

One major downside in DeFi solutions is that all the desired assets must exist on the same network. E.g. if I wanted a basket of 20 different L1 tokens, there’s no DeFi method to get them to coexist together, although I hear several X-chain projects are working fast to make that a reality.

Beethoven-x

I have been playing around with Beethoven-x, a Balancer fork on FTM. And one of their pools in particular, “The Magic Touch by Daniele”.

Near the top you see the tokens in this pool. There is MIM, a stablecoin, and wMEMO, a rebase coin. As we’ve seen in the previous article on levered LP-ing, adding a stablecoin lowers the volatility of the overall pool.

The wMEMO is also particularly interesting. If the other tokens go up in price faster than wMEMO rewards, wMEMO keeps accruing rebases. However, if other tokens stay constant or fall in price, the wMEMO rebases are “redirected” to buy the other tokens (we will probably re-visit the idea of yield redirection in a separate article).

Observation: in the line chart, we can see that the HODL performance (grey) vs pool performance (green) track each other very closely. The pool is relatively new, so we don’t yet have enough historical data to draw firm conclusions. We see that as of the time of writing (Dec 9, 2021), the pool is doing slightly better than HODL.

Observation: Near the bottom, you will also see that the pool has an APR of around 60%, which is rewarded in $BEETS tokens. And of course you can use an auto-compounder like Grim or Reaper to get an APY of around 80%. Note: the rewards are not included in the performance line chart.

Insight: Without rewards, several of our hypothetical portfolios earlier experienced impermanent loss. Now that we can collect a juicy yield on our portfolio, the yield should outweigh impermanent loss except in extreme situations.

Insight: With DeFi platforms, we can start constructing complex portfolios as well. For example, here we saw the introduction of a rebase token into the portfolio, which allows us to stack yield on top of yield. We could also introduce interest-bearing tokens and staked tokens into the portfolio. Taking it to the next level would be adding tokenized strategies (receipt tokens from other DeFi platforms, such as a-tokens, y-tokens, c-tokens, or even levered LP tokens 😉) into the portfolio.

A secret, for those who made it to the end

A little known secret, is that this article only contains half the magic. The other half of the magic needs to come from you, dear reader! I just know that we would have a blast when our ideas collide! Come @ me on twitter. Would love to see it!

Just a heads up: This post is just for education, and this post is not financial nor farming advice. This post assumes you have done some farming before. There are also data tables involved, if that scares you, do not worry. I’ve add some colours, just focus on the visual pattern of the colours inside the tables.

My goal for this post (and hopefully a future series) is to try to use some toy models, assumptions, common sense, and logic to develop a better understanding of the crypto market. I may be wrong in the assumptions I make and the conclusions I draw.

For further reading, The Defiant has well-written articles on levered yield farming: Levered yield farming explained and Levered yield farming strategies.

Yield farming

Just so we are using the same definitions, yield farming refers to depositing your assets with a protocol, which rewards you with a token, which is our yield.

We will be focusing on yield farming as a liquidity provider (LP) for a 2-token AMM, because the LP positions have a few useful properties that we can use to our advantage. There are also yield farm strategies through borrowing/lending platforms, multi-token AMMs, and token staking rewards on various platforms, which we won’t focus on here.

What is Levered Yield Farming?

Levered (or leveraged) yield farming is when you LP with borrowed capital in addition to your own capital. I might use the terms levered yield farming and levered LP-ing throughout. The upside is that we will earn more rewards, and the downside is we take on more risk (more on this later). Many platforms exist for levered yield farming! Here are a few off the top of my head: Alpha Homora, Alpaca, Francium, Tulip.

Toy example

Let’s use a toy example for illustration. Let’s strip away any transaction fees, yield, and borrowing rates for now, and just focus on the value of the LP position.

In these examples, we always start $1000 USDC, and we want to LP in a 50:50 ETH/USDC pool. Normally, when we LP, we swap half into ETH and deposit $500 of ETH and $500 of USDC into the pool.

In a levered yield farming protocol, we are allowed to borrow money. Table 1 below shows some common leverage values and how much money we are borrowing in dollar terms.

To understand leverage and debt, let’s look at 2x leverage column. In this case we have our initial amount of $1000, and the farming protocol lends us another $1000, and now we have $2000. We swap half into ETH and deposit $1000 of ETH and $1000 of USDC into the pool.

If we want to exit the pool now, we must return the $1000 that the protocol lent to us. If the value of my LP position falls to $1000, the protocol will liquidate me, sell everything back to USDC, and take back its $1000. I would be left with nothing.

This is the first risk and the most dangerous risk of levered LP-ing:

the risk of being liquidated when the price of ETH drops.

What happens when ETH falls in price

Our LP position will be worth less and less when ETH falls in prices, until at some point we hit the liquidation level. The following table shows us what our total LP position is worth, depending on our leverage level and ETH price decrease.

Where the cells are green, it means we will not be liquidated. Where the cells are orange, it means we are approaching liquidation. Where the cells are red, it means we are liquidated.

Observation: The liquidation level for 2x leverage is not at 50% ETH drawdown, as one might naively expect. In fact, ETH has to go down 75% for this position to hit liquidation level.

Observation: On low leverage values of 1.1x and 1.25x, the liquidation levels won’t be hit until ETH has a drawdown of >99% and >95%, respectively. To me, this is fairly impressive!

Observation: Even on the higher leverage side of 3x, the liquidation levels won’t be hit until ETH has a drawdown of >55%. This is still a quite generous safety buffer.

Insight: “ETH/USDC LP acts like a 0.5x long on ETH”

The reasoning behind the analogy is that the LP value experiences roughly half the volatility as ETH, since only the LP has 50% exposure to ETH.

What happens when ETH rise in price

Now let’s examine the second risk, impermanent loss, when ETH price continues rising.

But first, let us clarify a few things about impermanent loss.

Impermanent loss needs a reference to be measured against.

For example, if we are LP-ing $1000 in a 50/50 ETH/USDC pool, the following are all valid reference points:

1. Holding all $1000 in USDC (tells us how we are doing in PnL terms)

2. Holding all $1000 in ETH (tells us the opportunity cost of not going all-in on ETH)

3. Holding $500 in ETH and $500 in USDC (tells us how our LP strategy compares to not doing LP)

We are going to use definition number 3, as we are mostly interested in measuring how much we can optimize the LP strategy. Let’s call definition 3 the “HODL reference”.

We need several tables to keep track of things under different conditions, so brace yourself!

Table 3 below shows the overall value of our LP position, depending on leverage levels and on ETH price increases.

Next, we can see how much value our LP is worth once we repaid our debt. So we do Table 3 minus Table 1, and we get Table 4 below.

Next, we need our HODL reference for calculating impermanent loss. This reference value is what we would have if we just HODLed the initial $500 in ETH and $500 in USDC.

Now, for the grand finale, we are going to see how our levered LP strategies compare to the HODL reference. Take Table 4 divided by Table 5, and we get Table 6 below.

Looking just at the 1x leverage column, we can see that as ETH prices go higher, we are capturing less and less of the upside compared to HODL. If ETH does a 10,000% gain (100x), our relative performance is just under 20%, so impermanent loss is ~80%. This is definitely not ideal.

Now, if I may direct our attention to the red and green patches in Table 6. Red colours are values under 1, representing an under-performance compared to HODL reference. Green colours are values over 1, representing an over-performance compared to HODL.

“Over-performed” HODL? Did we beat impermanent loss?

Short answer is “Yes”, long answer is “Yes, up to a point”.

The reason why we outperformed HODL was that we borrowed money to buy more ETH. This increases our exposure to ETH beyond just HODL.

But if ETH prices keep going up, the LP keeps trading ETH for USDC. This would reduce our ETH exposure until it is less than HODL, and we would encounter impermanent loss again at some point.

Practically speaking though, if we look at the 3x leverage column, it is telling us:

Even if ETH did a 1000% (10x) gain, we are still beating HODL.

Which I think is simply splendid.

What about impermanent loss when ETH price goes down?

When ETH price is falling, the biggest risk is being liquidated, because then you would be left with nothing. Also, impermanent loss is not realized until I close the position and convert back to USDC. If I am longterm bullish on ETH, I would just keep the position open until ETH is back up again.

What about the trading fees, token rewards, and borrowing fees?

These are all variables that vary widely depending on your pool and market conditions. I’ve removed these from our example to make things simple, but also to examine the most conservative case in which we do not receive any rewards. That being said, in the vast majority of pools I’ve seen have APYs in the 3-4 digit range (net APY = trading fee + token reward - borrowing fees), and they work in our favour by increasing our LP size over time.

What does this mean for the average DEX user?

You will experience lower slippage, as leveraged yield farmers increase the liquidity on DEXes. Otherwise, it’s not very noticeable.

What does this mean for traders?

LP-ing allows us to express our market views, just as we can with options and futures. I don’t speak Greek, so I can’t say much about options. But if I did, it would be something along the lines of “just as options can be combined to create synthetic positions, levered LP positions can be combined to mimic options”.

Comparing LP-ing to perpetuals, I personally think LP-ing is much better suited to longer time frames. LP leverage starts at 0.5x by default and usually has a lower maximum leverage. On perpetuals, leverage routinely exceeds 10x or 20x, and much more suitable for short time frame traders.

Insight: With leveraged LPs, we have very high capital efficiency, we earn boosted trading fees and boosted farming rewards. If we can express our market outlook through a levered LP strategy, we should collect a much higher yield than through an options or perpetuals strategy.

Insight: With leveraged LPs, we always have capital to buy the dip. As long as leverage was not turned to max, when a dip comes, there is the option to borrow money through increasing leverage to buy the dip. *sluuurp*

Insight: We don’t ever need to close the position completely. We can think of the leverage as the accelerator pedal in a car. When you are more bullish, increase leverage, and when less bullish, decrease leverage. With this, we can achieve fine control over how we express our market outlook.

What does this mean for yield farm strategists

Insight: A simple strategy to boost yield with leverage while minimizing liquidation risk, is for every dollar you borrow, to put a dollar into a stablecoin yield strategy, such as Anchor Protocol or Curve3pool. When your levered positions are near liquidation, use the stablecoins you set aside to reduce leverage and avoid liquidation.

We’ve walked through one particular example here, which is LP in a volatile/stable pool. More complex strategies can be formed involve borrowing the ETH instead of borrowing the USDC, which in effect is a short on the ETH, if you want to express bearish-ness. You can borrow both ETH and USDC to create a pseudo-delta-neutral position.

A secret, for those who made it to the end

A little known secret, is that this article only contains half the magic. The other half of the magic needs to come from you, dear reader! I just know that we would have a blast when our ideas collide! Come @ me on twitter. Would love to see it!