Governance, YAM token liquidity, and token holder incentivization/rewards work best when they are considered together and can be implemented to support each other. As a DAO, we want to incentivize governance participation (delegation at the least), provide sufficient liquidity for the YAM token without paying exorbitantly for it, and reward token holders who participate in the achieving those goals. We can solve for these problems individually, but I hope that I can convince you that they are better solved together.
The first step is to combine governance and token liquidity. Many of the newer governance models that defi projects have been using involve some form of lock-up. This is often in a veCRV style variable-duration lock or a bonding process where it takes a certain amount of time to unstake voting tokens. These models have governance and security benefits and also assure that there are incentives to keep tokens off the market by providing supply sinks for them. But when these tokens are locked up individually, they don’t add any other value other than the governance benefits. What if we combined these governance lock-ups with liquidity provision to improve token liquidity.
DAOs need token liquidity. It allows new participants to enter and exit the organization and enables the DAO to craft token incentive programs on their own terms. Liquidity mining was a first attempt at liquidity acquisition by DAOs and it was very successful in bootstrapping enough liquidity at the launch of new projects. But DAOs quickly realized that paying directly to rent liquidity provision is an un-sustainable expense. Two solutions to this problem have been proposed: Buying liquidity permanently and leasing liquidity.
Buying liquidity was pioneered and popularized by OlympusDAO who built a product around providing tools for DAOs to purchase token liquidity. Liquidity purchased by the DAO does not need to be continuously incentivized and could be considered a capital investment for a DAO. The longer that liquidity is around, the less it costs, amortized over many years. Buying liquidity is the optimal long term solution if the funds are available to do so.
An intermediate option between buying liquidity and renting it via token emissions is to use liquidity derivatives (LP tokens) instead of governance tokens alone. A number of projects have begun using 80/20
govToken/ETH Balancer LP tokens as their governance tokens in order to combine governance and liquidity provision. 80/20 tokens have minimal impermanent loss risks and a relatively low requirement for outside funds (20% not in native governance tokens) which makes the inconvenience much lower than using the typical 50/50 Uniswap style LP tokens.
The third leg of this liquidity provisioning strategy is incentivization. Current liquidity mining programs rely almost exclusively on token rewards. On low volume assets like many DAO tokens, it is unlikely that fee volume will be enough to offset impermanent loss. To counteract this, tokens pay out high APRs to maintain liquidity. DAO owned liquidity no longer needs these incentives and the locked liquidity should be viewed as a shared common good of the DAO. But if a DAO cannot afford to fully purchase the liquidity it needs then it will still need to incentivize users to provide the rest. In this case, it makes sense to combine both the desire to reward governance and potentially provide dividend like benefits for a token with the need for liquidity. Providing token, or other incentives to stakeholders who deposit governance tokens to get 80/20 LP tokens and then actively vote or delegate can kill 2 birds with 1 stone. Combined with a protocol owned liquidity program, a DAO can set targets for liquidity and governance participation to maximize benefit.
I propose to use the framework above to create a plan for long term sustainable liquidity provision for the YAM token. It involves 3 parts that would work together, but could be completed individually. They are:
- Migrate YAM governance to use 80/20 YAM/ETH balancer pool tokens as the main voting token. These could be used alongside the YAM token alone or they could be used exclusively.
- Use treasury ETH to pair with minted YAM as an initial protocol owned liquidity acquisition. The amount should be calibrated based on the size of the treasury and assumptions around how much YAM will migrate into the 80/20 Balancer token.
- Reward participants who deposit and delegate their 80/20 LP tokens with treasury yield as discussed here. Additional YAM rewards can be given out to these depositors if desired.
What do we need to do to make this a reality?
In order to calibrate the quantity of ETH and YAM for protocol owned liquidity and incentives for voting, the DAO will need to set targets for different metrics.
As of June 6th, 2022 the YAM/ETH liquidity pool has ~$1,000,000 in liquidity. Ideally the DAO would shoot to match this amount of liquidity available in the market after making the changes above.
Lets start with the 80/20 LP tokens. These tokens provide roughly 40% of the liquidity that a typical 50/50 token does. (the 20% of base token and matched 20% of the paired token). If we want to get an equivalent amount of liquidity to what is currently available we would need to have 2.5x as much liquidity in 80/20 tokens, or $2,500,000. This would equal $2M in YAM and $500k in ETH. Considering that YAM has a current marketcap of $2.8M, this is very aggressive and probably an unrealistic goal. A more realistic goal may be to aim for 40% of the YAM circulating supply deposited in the 80/20 tokens ($1.12M worth of YAM, or $1.4M worth of 80/20 tokens). This would provide approximately $560,000 of liquidity.
With a target of 40% of YAM in the 80/20 pool, we can calculate that the DAO would need to make up $440,000 in purchased liquidity to meet the current condition. This would cost the DAO $220,000 worth of ETH if it minted new YAM to pair with it in a 50/50 pool. That comes out to about 15-20% of the current treasury ETH.
I believe that this ETH should be considered unavailable to the DAO once committed to protocol owned liquidity, but it could be removed in an emergency or if another mechanism to provide liquidity is implemented. Like with any liquidity provision, if the price of YAM drops, this pool will end up with more YAM, and if the price increases, less YAM.
The above calculation assumes that $1.4M in YAM/ETH LP tokens are created and used in governance. In order to make this a reality, we will need to add some kind of incentivization. It is almost impossible to guess what will be “enough” but we can at least give a sense of what is available.
The treasury has about $1.75M in stablecoins and about another $1M in ETH (after using some for protocol owned liquidity). There are other assets in the treasury, but they are going to be harder to use in a yield distribution system. Some could be sold, but lets assume for now that the DAO has about $2.8M in assets that it can draw yield from. This is roughly double the amount that we project to have locked in 80/20 tokens, so if we distributed all of the yield earned by that portion of the treasury it would account to all token holders receiving 2x the expected yield of their LP token value if deposited in yearn as USDC and stETH. This may not seem like much, but it is real yield in USDC and stETH and while the YAM price is volatile, the yield profile will continue to match that of the Treasury assets.
There are options to design this system with either yield tokens from element.fi or by taking out self-repaying loans using Alchemix. Both options have trade-offs which need to be evaluated and discussed. There is even an option to use both, which would lower the yield for governance, but protect the treasury’s principal and keep the yield.
Furthermore, there is always the option to use YAM for some level of incentivization if desired, and low levels of YAM issuance directed toward governance participants should be considered because it provides a way for those who benefit the DAO to slowly increase their share of tokens while those who do nothing are diluted.
In order to make this a reality, there are technical issues to consider:
- How realistic are the targets set in the document?
- We need to add the YAM/ETH 80/20 LP token to the YAM Governor contract or create an incentivizer contract to add to the governor contract. The incentivizer contract can double as a locking contract with a cooldown. What parameters do we want this contract to have?
- When desired, the rewards on the existing incentivizer will need to be turned off. We should probably also migrate from Sushiswap to a Balancer 50/50 pool for the purchased protocol owned liquidity to make things simple and make interfaces to purchase and sell YAM easier. if Sushiswap ever gets their act together and releases a balancer equivalent variable weighting pool then we could use that instead for both parts.
- How do we design and implement the yield distribution mechanism? I will write about element and alchemix as different options soon.
- Do we want to include any YAM incentives?
I strongly believe that the future for many governance tokens is going to include leveraging 80/20 (or other weight) LP tokens in governance and other functions to help maintain a minimum amount of liquidity for the native token. Pair this with a productive use of the treasury to help connect the its inherent value with that of the YAM token. There are multiple moving parts required to make this all happen along with the changes to the YAM organizational structure and deciding upon an issuance model, but we have an opportunity to innovate and move YAM forward and into a modern DAO.
There have been a number of previous posts on protocol owned liquidity and governance that this post builds on. Take a look at them here:
Governance: A Roadmap for YAM (Part 2 - Governance)
Treasury Yield Distribution: A Roadmap for YAM (Part 3 - Tokenomics)
Protocol Owned Liquidity: A Roadmap For YAM (Part 4 - Protocol Owned Liquidity)
Feddas’ post about protocol owned liquidity: YIP: Multipart Yam Treasury Rehabilitation Proposal