After over 2 years with barely any meaningful innovation in liquidity mining, the IPOR Protocol introduces a new DeFi primitive.
- Liquidity mining is a powerful incentive mechanism that is uniquely suitable for DeFi projects.
- In the past two years, a number of serious flaws in liquidity mining designs have become apparent.
- Power Tokens seek to iterate over the veCRV design in search of a more sustainable and long-lasting liquidity mining mechanism.
- Power Tokens attempt to improve existing weaknesses in liquidity mining and tokenomics design to create a modular, adaptable DeFi primitive that other protocols can modify in accordance with their unique requirements.
Token incentives for bootstrapping DeFi protocols have been all the hype since the DeFi Summer of 2020. Originally pioneered by Synthetix in 2019 with their now famous StakingRewards.sol, Liquidity Mining (LM) was the primary catalyst spearheaded by Compound’s LM campaign.
LM contributed to DeFi’s explosive growth from around $1 Billion at the beginning of 2020 to approximately $200 Billion in fewer than 2 years. LM is now the de facto standard for bootstrapping protocol liquidity & activity as well as decentralizing governance by distributing tokens to protocol users.
Why do DeFi protocols run liquidity mining programs?
- To incentivize governance participation and achieve progressive decentralization of the protocol.
- To reward users for bootstrapping the core functionalities of the protocol (liquidity for AMMs, lending/borrowing for credit markets, yield generators for aggregators, or options markets).
- To reward long-term token holders (designing token value capture/utility to ensure that the token inflation caused by the LM program will be offset by an increase in the “value” assigned to the utility of the token).
LM exists as an incentive mechanism not only in DeFi but also at the base of blockchains (Layer 1s) in the form of staking rewards, where token emissions go towards validators/miners to subsidize and bootstrap network security. DeFi contributed to token economics by empowering users and providing the tools to iterate and tweak protocol parameters via decentralized governance. The use of governance tokens has enabled those token-powered decentralized organizations to achieve growth and long-term sustainability.
The current limitations of liquidity mining designs
As more DeFi protocols were developed which experimented with different token economic models to achieve those objectives, key problems and flaws became apparent such as:
- Failure to bootstrap an engaged community active in governance participation.
- Lack of incentive alignment between liquidity providers (LPs) and the protocol’s long-term interests, hampering sustainability.
- Excessive token emissions from incentive programs coupled with token locking create massive demand in the short-term followed by merciless token dumping, often exacerbating boom and bust cycles commonly described as “mercenary capital”.
- Lack of token value capture/utility outside of fueling speculative games that quickly leave holders rekt after the initial FOMO is gone.
Dealing with voting apathy and irrational token emission
The question “How to achieve decentralized governance and overcome voter apathy” plague many DeFi protocols. Governance is difficult, and keeping up with multiple projects makes the task even more daunting for the average user. As such, proper design around token and governance onboarding should seamlessly introduce the Protocol participants to governance. Taking into account what has happened in the past 2 years, it is apparent that protocols that link governance tokens with their LM programs are benefiting from much higher participation and form stronger, more diverse decentralized communities than those that do not.
The second set of problems is mainly caused by protocols competing for short-term attention.
This is probably the right time to acknowledge Curve.Finance and their innovative design of veCRV. While hordes of protocols rush to copy the veCRV design they fail to take into consideration the specific traits that make veCRV work. We believe that new protocols launching tokens should adopt a less volatile and more balanced approach, especially in the early days. After all, few protocols reach the daily volumes of Curve, specifically considering not only that Curve has already become the centerpiece for swapping pegged assets, but also plays a core role for other protocols to earn yield.
Power Tokens: A new DeFi primitive
After deep study and analysis of Curve Finance and the features that make it tick, we seek to address the strengths and weaknesses and adapt them to create a new DeFi primitive: Power Tokens.
Power Tokens seek to iterate over the veCRV design in search of a more sustainable and long-lasting mechanism. Its design embraces the compounding economic benefits of the value accrual mechanism while aligning the incentives of protocol users and liquidity providers.
Similar to veCRV or stkAave, Power Tokens are a staked representation of the protocol’s native token and serve as the de-facto governance token of the protocol. Obtaining Power Tokens is seamless.
This otherwise simple change in design brings multiple benefits to both the protocol and its users. By distributing rewards as Power Tokens, the protocol naturally limits the float of circulating tokens, allowing the market to more gradually absorb the potential sell pressure resulting from emissions.
Additionally, it seamlessly introduces users to the benefits of holding governance tokens as their yield is automatically enhanced (via the power token multiplier) and they start earning additional rewards from protocol revenue.
Finally, while it does not completely disincentivize mercenary farming, the design heavily reduces the effectiveness of such practices by introducing the power token multiplier, requiring LPs that want to compete for yield to delegate (power up) Power Tokens to the pools where they are providing liquidity.
Multiply your yield
The primary objective of the yield multiplier is to better align the incentives between LPs and the protocol. In the case of Power Tokens, each user’s individual multiplier is a function of the number of Power Tokens they have delegated and the amount of liquidity that they have provided to the pool. The resulting multiplier sits on a logarithmic curve with two distinctive characteristics:
1. The beginning of the curve has a steeper slope, allowing users to obtain a higher multiplier while preserving very high capital efficiency.
2. As the multiplier increases, the slope of the curve slowly flattens, making it costlier and less capital efficient for LPs to further increase their power-up.
This allows for a broad and fair distribution of the protocol’s governance tokens from the liquidity mining program towards LPs and reduces the likelihood of only a few large liquidity providers monopolizing the earning of rewards from the reward pool (effectively pricing out or reducing yield for other participants).
For a more detailed visualization, the tables below summarize the technical and economic design of Power Tokens.
From a technical point of view, the design of Power Tokens is geared towards modularity. The base contract allows for the delegation of a user’s Power Token balance to the staking contract without transferring the underlying balance. This delegation method allows multi-purpose use of the Power Token. A user can optimize their liquidity mining rewards across multiple pools. At the same time, the governance module allows the user to delegate their Power Token to a representative who could vote on their behalf on DAO proposals. Abstracting the logic of Power Token use from the Power Token balance management allows for greater flexibility and future growth of Power Token applications within the protocol ecosystem.
Redeeming Power Tokens for the underlying tokens is only possible when the Power Tokens are not currently being used in any of the modules. This ensures that tokens can not be “double spent” or “double used.”
The process of staking and liquidity mining consists of 3 distinct actions:
- Staking LP tokens into the reward contract
- Staking the protocol’s native token to receive Power Tokens
- Delegating Power Tokens to “power up” liquidity mining
Each token has its own Staking Pool. Liquidity providers can stake LP tokens into the rewards contract which immediately entitles them to start claiming mining rewards at the base multiplier. To boost rewards, Power Tokens must be delegated to a particular staking pool. The liquidity provider can choose how to distribute the Power Token between all the pools where they might provide liquidity.
There are 3 distinct differences when compared to established vote-escrow models:
- No long locking of tokens: To obtain a higher multiplier a user simply needs to delegate (power up) more Power Tokens to the pool where they are providing liquidity. To redeem power tokens to a liquid ERC20 token a user simply initiates a redeem function (14 days cool-off).
- No hard cap on the multiplier: The more you delegate, the higher your multiplier (diminishing returns occur as the ratio of delegation to liquidity increases). The combination between this and the previous point allows the user much greater control and the ability to rebalance between liquidity and Power Tokens to achieve optimal effective APR for their specific position. It also brings much more clarity when trying to assign a $ value of the utility to each delegated Power Token provided.
- There is separate logic (module) for each of the main token utilities (multiplier, voting power, revenue share, etc.) giving increased flexibility to protocols to fine-tune those modules to meet their respective desired objectives.
Power Tokens were born out of the inspiration of innovative models such as the veCRV mechanism while attempting to improve on their weakness to create a modular, adaptable DeFi primitive that other protocols can adapt in accordance with their needs.
After almost 2.5 years with barely any meaningful innovation in liquidity mining (mainly due to technical and economic design complexity), the introduction of the Power Token design allows protocols to continue their search to innovate and implement long-term sustainable token rewards for their protocol users. It presents a framework for optimized contract architecture combined with a new economic design focused on utility and market-driven price discovery.
The Power Token design overcomes inherent tradeoffs of liquidity mining incentives by:
- Improving market efficient dynamics and promoting price discovery.
- Facilitating decentralization from the core economic mechanism.
- Creating robust and long-term protocol engagement.
- Disincentivizing mercenary capital.
The IPOR Protocol embraces decentralization and community governance at its core. The Protocol contains multiple DeFi primitives which can be leveraged by other protocols. Therefore, credible neutrality is key.
The IPOR Index, the benchmark interest rate for DeFi, will be governed by DeFi participants and transparently provide markets with reliable interest rate information. As we expect other teams to build on top of the IPOR Index and IPOR interest rate swaps, so too will the Power Token primitive be open-sourced to the community of DeFi builders.