Messari interprets Tokemak: "Core Efficiency" of Liquidity as a Service

Original Title: "Tokemak: Nuclear Efficiency of Liquidity as a Service"
Written by: Ryan Swanson, Messari Researcher
Translated by: Block unicorn

The early 2000s .com boom ushered in a new era of innovation and entrepreneurship in the emerging internet space. However, the lack of computing infrastructure was an industry-wide issue that had the potential to stifle explosive growth. Tech startups spent increasing amounts of time and money building and maintaining their server farms instead of investing in their products or teams.

The solution to this systemic weakness came in 2006 with the introduction of Amazon's AWS, which outsourced IT infrastructure and introduced the concept of "pay-as-you-go" server farms. Today's DeFi ecosystem faces similar infrastructure risks and different fundamental issues: liquidity.

Just like in the early 2000s, teams are spending more and more time procuring, guiding, and incentivizing liquidity rather than developing their protocols. Tokemak's Reactor model aims to address this issue by establishing critical liquidity infrastructure in the form of liquidity as a service (LaaS).

Liquidity as a Service

The significant growth of DeFi TVL on Ethereum, which recently surpassed $200B, is partly due to the outrageous APYs offered by many protocols. These irresistible yields attract investors looking to capitalize on yield opportunities rather than the underlying protocols. Once the rewards dry up, these hired liquidity providers withdraw their assets and move on to the next opportunity, leaving behind diluted tokens and underutilized protocols.

The LaaS model aims to provide an alternative approach by outsourcing liquidity procurement and guidance to third parties (i.e., Tokemak). To understand how this critical infrastructure service works, we need to look at the outsourced infrastructure supporting today's DeFi ecosystem.

Power Layer

The first layer includes the generation and distribution of energy, in this case, electricity. Without electricity, there is no internet, and without the internet, there is no entire digital asset ecosystem. The impact of public power infrastructure has radiated to every corner of human life, leading to humanity's greatest technological achievements to date.

Computing Layer

The most revolutionary creation of the electronic age may be the internet and personal computers. The internet reflects a decentralized system of computers communicating with each other without centralized operators; however, as the open-source nature of the internet evolved, the computing requirements needed to support these platforms encountered the first scalability issues of the digital age.

As mentioned in the introduction, the transition from Web 1.0 to 2.0 during the internet boom of the 90s created an increasing demand for computing power that personal computers could not bear. The lack of scalable computing infrastructure required startups to procure and maintain their proprietary server farms, wasting time and money that could have been better spent developing products and growing teams.

The pay-as-you-go or "cloud-based" information technology introduced by companies like Amazon, Microsoft, and Google alleviated this scalability constraint and accelerated the development of Web 2.0. Liquidity is the computing power of the digital asset age, and LaaS providers like Tokemak are the infrastructure participants hoping to accelerate Web 3.0 growth in a similar way.

Liquidity Layer

Similar to the challenges faced by startups during the dot-com era, liquidity has become a critical aspect of every DeFi protocol, requiring significant time and resources that could be better used for development and growth. So far, mining rewards have been the source of liquidity and the driving force behind the rapid growth of TVL across the entire DeFi ecosystem.

However, inconsistent incentives between protocols and liquidity providers have created an extremely fragile liquidity system that constantly faces the risk of evaporation once rewards decrease or higher-yielding projects emerge.

The high-risk, high-cost model of liquidity mining threatens the scalability of the digital asset ecosystem. However, just as "pay-as-you-go" emerged as a bridge from Web 1.0 to 2.0, Liquidity-as-a-Service also appears to be the bridge to Web 3.0.

While still a new concept, LaaS platforms have already been introduced in various styles. Messari analyst Chase Devens explained in his notes that beyond DeFi 2.0 protocols, LaaS providers allow protocols to "directly purchase their liquidity from the market or rent it from protocols designed to provide the cheapest yet highest quality liquidity."

The chart below outlines the relative positions of major LaaS providers and their liquidity spectrum. On one end is traditional liquidity mining, which is considered the shortest-term (and highest-cost) form of liquidity due to the aforementioned risks. The Fei Protocol recently launched a LaaS platform in collaboration with Ondo Finance to generate short-term liquidity that can essentially be turned on or off on demand.

On the other end of the spectrum, you have providers like Olympus Pro, which allows protocols to own their liquidity through the Olympus (OHM) bonding program, similar to preferred stock, where liquidity miners purchase protocol bonds to generate protocol-controlled value (PCV) in exchange for the spread between the bond and asset market price.

Tokemak sits between these models. While the liquidity generated for protocols may not increase the value owned by the protocol like Olympus Pro, it is a long-term model and provides Tokemak with slightly different incentives, retaining all generated trading fees in exchange for taking on the risk of impairment losses, which the Fei x Ondo model does not have.

A good way to consider these different LaaS models is to compare them to traditional fixed-income products. If Olympus Pro resembles preferred equity that looks like debt but operates like equity (i.e., a growing PCV), then Tokemak is closer to traditional bonds, where the protocol borrows liquidity in exchange for fees charged to Tokemak in the form of trading fees.

Following this model, the Fei x Ondo Protocol's model is similar to that of commercial paper, a form of very short-term debt financing that typically charges slightly higher interest than bonds but provides borrowers with greater flexibility. Fei's ability to rapidly open and close liquidity flows operates in a similar manner.

Finally, this leaves us with traditional liquidity mining, which, due to the lack of better examples, resembles procuring critical operating capital from strangers on the street by offering extremely high APYs. Through this lens, it is not surprising that when yields decline, the trustworthy financiers on the street are less likely to return. While each LaaS model has its pros and cons, Tokemak's Reactor model presents a truly decentralized liquidity generation system that is distinctly different from its peers.

Tokemak Reactor Model

Tokemak's business model is designed as a decentralized market maker that decentralizes the scarce resources controlled by traditional market makers: capital, market knowledge, and technology. In Tokemak's model, the protocol acts as a technological component, with its capital and market expertise coming from third parties known as liquidity providers (LPs), liquidity directors (LDs), and pricers.

Liquidity Providers (LP)

LPs are asset holders, which can be individuals or groups (i.e., DAOs, exchanges, protocols) who wish to earn returns on their idle assets (paid in TOKE) or support increased liquidity for their respective protocols. LPs provide the assets for Tokemak's bi-directional liquidity pools, known as Reactors, in exchange for "Toke Assets" or tAssets.

Liquidity Directors (LD)

LDs hold Tokemak's native currency TOKE, which serves as tokenized liquidity and governance for liquidity supply. LDs stake their TOKE into an asset Reactor, supporting the other end of the aforementioned bi-directional liquidity pool. By placing their TOKE in a given Reactor, LDs signal to LPs to allocate more liquidity to the Reactor.

Liquidity is then deployed to various exchanges or trading venues as determined by LD voting. At launch, Tokemak will be able to deploy funds across five exchanges: 0x, Sushiswap, Uniswap, Diversifi, and Balancer.

The asset returns for LDs are similar to those for LPs. However, LDs can choose from any active Reactor, each offering different APYs based on the Reactor's Asset-to-TOKE ratio. The APY on either side of the liquidity pool increases or decreases depending on the relative 1:1 ratio of assets to TOKE.

If a Reactor has more assets than TOKE, the Reactor will incentivize LDs to stake their TOKE; if the Reactor has more TOKE than assets, the Reactor will incentivize LPs to stake their assets. LDs are responsible for maintaining balance among all Reactors. LDs are encouraged to do this because balanced Reactors will produce the maximum emissions, while unbalanced Reactors face the risk of failure, putting LDs at risk of emission reductions or even impermanent loss.

LDs lacking market knowledge or wishing to actively guide liquidity between Reactors can place their TOKE directly into the protocol, providing a proportional share of all Reactor earnings. TOKE holders choosing this method will forfeit voting rights at the more granular exchange/venue level.

Tokemak earns trading fees from liquidity-oriented exchanges. These fees are then retained in the Tokemak treasury as protocol-controlled value. Over time, Tokemak aims to accumulate enough trading fees to independently guide liquidity without the need for LPs. This self-sustaining point is referred to as the "singularity."

Pricers

The final part of the Tokemak equation is the Pricer. Pricers are used to facilitate the demand for real-time pricing information for any protocol not using automated market makers (AMMs). In these cases, Tokemak will rely on Pricers to set buy and sell order prices using separate Tokemak asset pools to maintain the market for the assets.

Singularity and Tokemak DAO

For any DeFi veteran, Tokemak's model may seem like just a form of outsourced liquidity mining, which the protocol is indeed designed to alleviate. However, the platform aims to eliminate the need for new LP assets in the long run, relying solely on Tokemak's PCV to guide liquidity for the entire ecosystem.

Similar to how Olympus DAO retains assets in the protocol treasury, Tokemak aims to accumulate enough assets through trading fees to fund the asset side of the Reactor pools themselves. The term singularity refers to the point in time when this may occur. The Tokemak team has not provided details on when they expect the singularity to happen. However, with the establishment of TokemakDAO, the outcomes of such events will usher in the next chapter for Tokemak.

While today's TOKE holders retain some governance rights, once the singularity is achieved and TokemakDAO is formed, control of the protocol will fully transition to the DAO, with the primary focus on compensating LDs. The singularity does not require third-party assets to balance the Reactors, so LDs will maintain bi-directional control over liquidity through their Reactor and exchange-level voting rights. To reward TOKE holders and compensate LDs, the initial governance votes are expected to focus on allocating protocol fees to TOKE holders.

The singularity presents a tremendous opportunity for DeFi to address its liquidity issues in a decentralized manner. If realized, Tokemak will be able to provide liquidity to any project the community deems attractive, alleviating developers' need to acquire liquidity and pay mining rewards. The reliance on centralized market makers may completely vanish, and a new era of scalability may exist independently, beckoning the true potential of Web 3.0 and decentralized finance.

Project Roadmap

The Tokemak team has made significant progress toward achieving its goals and has garnered considerable attention and investment in the process. Tokemak's roadmap began in the summer of 2021 with the launch of the zero cycle. Considering the pre-launch cycle, the zero cycle consists of three phases.

DeGenesis Event

The initial liquidity accumulation phase of Tokemak and the precursor to the zero cycle, where whitelisted users could deposit ETH and USDC to gain access to the first TOKE emission pool. DeGenesis sought to raise $24 million in reserve assets by providing individual ETH wallets the ability to purchase up to $100,000 worth of TOKE at a variable price, depending on the amount of commitments received by the end of the window.

At the maximum commitment level of $24 million, each commitment would exchange for $8/TOKE, resulting in each wallet being able to purchase up to 12,500 TOKE. Commitments exceeding $24 million and up to $48 million were eligible for a private "Genesis" farm to earn TOKE emissions at an accelerated rate.

For example, if someone were to submit $1,000 USDC to DeGenesis, and the event ultimately raised $48 million, that investor would be able to purchase $500 worth of TOKE at $8, with the remaining $500 qualifying for the Genesis pool, where it would earn additional TOKE emissions.

DeGenesis ended on August 4, raising a total of $36.56 million, with $12.56 million allocated to the Genesis mining pool. Notably, 70% of the committed funds were increments below $10,000.

Genesis Pool

After DeGenesis concluded, the Genesis Pool launched the zero cycle, introducing a private Genesis pool for ETH and USDC commitments exceeding the DeGenesis cap. These pools were private for the first two weeks and offered oversized emission rewards to compensate DeGenesis participants.

In addition to the Genesis pool TOKE, Sushi LP, and Uni LP pools being made public, non-DeGenesis participants had to purchase TOKE on the open market to participate. The Genesis pool will continue until the end of the zero cycle and the start of liquidity direction.

Core

The Reactor Staking Event (CoRE) began on September 28 and lasted for a week. This marked the first TOKE governance event, as TOKE holders were able to vote to support the first five Reactors to be established. The Tokemak team compiled an initial list of 42 established DeFi projects, with the top 5 vote-getters qualifying for Tokemak Reactor.

Each staked TOKE token received 1 vote, while each staked TOKE (tTOKE) received 4 votes, and Sushi/Uni LP token holders received 69 votes per LP token. CoRE ended on October 5, with the final review period occurring on the 6th. Ultimately, Tokemak's first CoRE received approximately 35 million votes, with 57.7% coming from non-staked token holders. The five projects chosen for the Reactor were Frax Finance, Alchemix, TracerDAO, OlympusDAO, and SushiSwap.

Following the first CoRE, the Tokemak team is actively collaborating with various protocols to fund their Reactors. This process will involve a 1:1 token swap to initially fuel the Reactor and provide ample liquidity guidance for the projects by holding TOKE. So far, Frax, OlympusDAO, Alchemix, and TracerDAO have all funded their Reactors.

Once the initial Reactors are established, the zero cycle will conclude, and as LDs begin to guide liquidity between exchanges and their respective DAOs benefit from low-cost, stable liquidity, Tokemak's true power will be unleashed. Core 2 is planned to begin in early November, with core stakeholders receiving reward voting rights equivalent to the amount held during the first voting period for their TOKE/Sushi LP/Uni LP.

Looking ahead, establishing additional Reactors will be a priority until Tokemak builds a sufficiently large treasury to achieve the singularity. When Tokemak's treasury no longer requires external LPs, the DAO will be established, and the reward structure will be adjusted.

Future Liquidity

While relying on mining incentives to drive liquidity has served the DeFi space well so far, the ecosystem continues to evolve, and the inconsistent incentives between protocols and LPs pose significant scalability risks. Just as AWS revolutionized IT infrastructure and accelerated the transition to Web 2.0, Tokemak's LaaS model aims to fundamentally change protocol liquidity, providing the necessary infrastructure to support the transition to Web 3.0 and beyond.

Source link: messari.io