Liquidity After Bootstrapping
The 80/20 standard for incentivizing continuous token liquidity
Balancer Liquidity Bootstrapping Pools (LBPs) have proved themselves as an optimal mechanism to conduct a new token launch. LBPs have consistently grown in usage and typically the immediate next step for projects at the end of their IDO is to migrate some amount of their newly raised capital to seed a liquidity pool that will best serve their protocol and their community.
This piece will make a case for the ideal post-sale liquidity allocation to ensure fast-building and long-lasting liquidity for a recently launched token.
For Those of Us With Short Attention Spans (TLDR):
- A token needs a liquid market for it to thrive long-term
- Balancer 80/20 pools attract liquidity both from token holders who value long exposure and from typical LPs seeking to generate passive fees and incentives
- Dynamic fees and dual liquidity mining distributions are among several tools for further incentivizing liquidity on Balancer V2
LBP Succession
In any quality project, it makes sense for both the founding team and the community to optimize their actions towards the longstanding prosperity of the project rather than short-term profits.
Imagine a team that has just completed a successful liquidity bootstrapping event on Balancer, consisting of their new token $TKN and $USDC — starting at 90%/10% $TKN/$USDC and shifting to 10%/90% by the end.
Important factors for project growth are liquidity and a healthy market — without them, it’s harder to build an investor base and the project may gain insufficient attention. A single liquidity bootstrapping event will, unfortunately, not cut it — the project likely needs large amounts of liquidity throughout its whole lifecycle.
The second-order effect of ample liquidity is that a larger group of people can participate in the market, effectively popularizing the token and improving its distribution, which is a key metric for most projects, especially for governance tokens. For this reason, it’s in the best interest of both the team and community to establish long-lived liquidity for their token as early as possible.
In our example, the team now has a war chest of $USDC in their treasury and the community has valuable $TKN they want to hold for the long term.
A good chunk of that $USDC surplus can be invested into a new liquidity pool, benefitting the project in three ways:
- Generating trading fees for the treasury
- Earning BAL liquidity mining distributions for the treasury
- Providing a market for the project’s token
In the same way, and for the same reasons, it makes sense for the community to invest a portion of their newly bought $TKN into the new pool.
The Golden Ratio: 80/20
As the community wants to hold the token long term, the project would be wise to migrate their LBP liquidity to a pool that favors holders of $TKN, by choosing an 80/20 structure — where 80% of the pool’s value is held in $TKN.
The other 20% of the pool might be held in ETH, or in a stablecoin like USDC. An 80/20 TKN/ETH pool is preferable to LPs with a crypto-bullish bias, wanting to retain overall crypto exposure.
Fun fact: the 80/20 AAVE/ETH and 80/20 BAL/ETH pools are two of the largest pools on Balancer by market cap.
Overall, an 80/20 liquidity pool is an optimal configuration for a newly launched token. The uniquely flexible design of the Balancer protocol makes it the only AMM that supports an 80/20 weight configuration, and thus the ideal place to concentrate liquidity post-sale.
Drawbacks of Vanilla 50/50 Weights
Any project that has just undergone launch is inherently still in price discovery, potentially for months after the initial LBP event.
In the same way, it is likely that major project developments are just beginning to ramp up (e.g LBP proceeds are invested in hiring).
50/50 pools create a split between two factions of token holders who are inherently at odds with one another. The community of true believers who invested in the token believe it will appreciate in the long term and want to HODL their tokens in order to maintain exposure to the potential upside. On the other hand, liquidity providers of a token typically believe that their trading pair will see a good amount of volume, earning them revenue from swap fees.
When liquidity is concentrated in a 50/50 pool, the incentives of these two groups are in conflict.
- LPs take on growth risk, where any sudden price changes can cause them impermanent loss. They win if the token continuously trades in a tight range without mooning.
- HODLers are reluctant to put their assets to work, as they would risk missing out on the token upside they expect. Because of that, their assets remain unproductive in their wallet. They win by waiting for the token to moon.
Ideally, a project would want both of these groups to be aligned in order to maximize both the amount of liquidity provided by LPs and the crucial contributions from community HODLers supporting the project.
Aligned Incentives
Providing liquidity to a pool that is unevenly split 80/20 more accurately expresses bullish conviction in a newly-launched token — it is closer to mirroring classic holding but also carries LP benefits.
From the community’s perspective, investing part of their $TKN into an 80/20 pool can be seen as an optimal investment strategy, since they would benefit from all three things:
- Token price appreciation
- Trading fees/liquidity mining incentives
- Token market/ecosystem growth
As a HODLer, providing liquidity with part of one’s $TKN assets can be seen as a hedge against both prolonged price stagnation periods and price drops.
In the scenario of stagnating price, HODLers benefit from passive pool income, and in the massive price drop scenario — they stand to (impermanently) lose a bit less compared to a 50/50 pool. Because of this, pure HODLers don’t perform that much better than 80/20 LPs — especially during bear markets.
Additionally, simply holding is not constructive to the project’s longevity as it equates to refraining from helping to build a liquid market for the token. Holding is a sort of standoff event, where the token’s total liquidity is impaired by a lack of liquidity provision.
Low liquidity leads to stagnation of trading activity and token value, as investors and contributors are less interested in participating. The opposite — active LPing by a large number of community members — stands to spin up a positive network effect which leads to greater aggregate liquidity and therefore market growth.
As such, any project team would be wise to follow a strategy that both incentivizes liquidity for their token and brings long-term project supporters off the sidelines to participate in market making while maintaining significant skin in the game.
Further LP Incentives
Additional levers can be pulled to better incentivize LPs, like enabling dynamic swap fees, community-governed fees, and integrating a liquidity mining program.
Balancer V2 offers dynamic fees (powered by Gauntlet), which react to market conditions to continuously adjust swap fees for optimal LP performance, as well as making a TWAP available for the token.
Community-governed fees are also an option, whereby the pool’s fees can be set and changed by community vote. Some communities may prefer a 1% swap fee, which encourages a long-term mindset for liquidity providers, making it prohibitive for short-term LPs to swing trade in and out of the pool, and strongly rewards LPs who get in early.
The Baller committee, which governs liquidity mining allocations for Balancer V2, has stated their decision to give priority to projects that conduct LBPs and then migrate liquidity into Balancer V2 pools — an opportunity to offer powerful incentives for building a liquid market.
Balancer V2 will soon use staking contracts to distribute BAL to selected pools and the Balancer community is actively seeking partnerships with promising projects to utilize this. These dual incentive staking contracts are capable of distributing both BAL and a project’s token to LPs in a specific pool.
Balancer V2 Improvements
In the past, three key issues disincentivized teams from choosing Balancer V1 pools for their post-IDO liquidity: lack of aggregator integrations, no USDT support, and relatively high gas costs.
Balancer V2’s single-vault architecture has significantly reduced the complexity of integration, making it easy for aggregators and smart wallets to tap into Balancer V2 liquidity. It supports USDT. And gas optimizations, as well as the integration with Gnosis make it the most gas-efficient L1 DEX for traders.
Special thanks to Balancer community members Stanislav Kozlovski, Solarcurve, and Jeff Bennett for collaborating on the research, writing, and editing of this piece.
Follow Balancer
Twitter | Discord | Website | Forum
