Rethinking APY for rebase token protocols
--
Rebase token protocols, like Olympus, Wonderland, Klima, Redacted, promised their users 5 digits and 6 digits APY. However, in the recent “bearish” market, most of the users buying into these protocols ended up getting rekt. So, if the APY is not a good gauge of whether you will make positive returns on the protocol, then what will?
In this article, I’ll deconstruct the “APY”, share a simple way to model the price movement for such protocols, and finally explain the mental model we use at Bluejay Finance when thinking about staking rewards.
”APY” is a misnomer
APY stands for “annual percentage yield” and is often used to compare the returns of financial products with varying compounding schedules. For APY to be useful for comparison, we need to compare them in the same base currency (ie USD).
However, different protocols quote the APY using the native governance token, not USD, as the base currency. This adds a new layer of complexity in modeling the returns.
When a product promises a 50,000% APY, it means you will get 500x the amount of tokens you stake at the end of 1 year. However, the actual return denominated in USD will vary largely depending on the price of the governance token in a year:
- Token price is 1/1000th: you lost half the value (in USD)
- Token price is 1/500th: your investment is worth exactly as much as it was (in USD)
- Token price is the same: you made a 500x return on the investment (in USD)
- Token price is doubled: you made a 1000x return on the investment (in USD)
What you can be (somewhat) certain about is how the token in your wallet will grow. What you have (almost) no certainty about is how the price will change during this period of time.
The APY in this case merely is the inflation rate of the governance tokens supply [1]. In fact, having staking APY alone has no effect on the returns of your total investment.
This model is not native to DeFi world. In the TradFi world, some companies will choose to perform a “stock split” in which one share of the company is split into multiple parts. In the Tesla five-for-one stock split in 2020, you will receive 4 additional Tesla stocks if you hold one Tesla stock before a given date. Guess what happens to the price of Tesla after the stock split? It becomes 1/5th of the original price.
So rebase token protocols are really simply doing a continuous stock split.
So why do they do that?
Traditional companies perform stock splits as a way to make the stock more affordable and enticing to individual investors after the stock price creeps up and begins to look expensive. Splitting the stocks helps increase a stock’s liquidity in the market and prevent smaller, and often later-stage investors, from being crowded out.
DeFi protocol can benefit from the continuous stock split to allow early investors to sell their tokens when they feel richer, and allow later-stage investors to buy in at reasonable prices. Increasing the supply has the effect of making everyone feel richer so they spend or trade more. In fact, that’s the reason why governments give out stimulus checks or decrease interest rates when the economy is in a slump to encourage spending.
So if we cannot use APY to model the investment returns, how should we do it?
Rethinking APY as Inflation Rate
If we look at the current supply of the token and the price of the token, we can get the current market cap of the protocol. This gives a vague estimation of how much the market thinks the protocol is worth currently.
However, the model is not static because there is a flow of funds (from the sale of bonds) and there is continuous inflation of the token supply as existing tokens are staked for more tokens.
Think of the token supply as the base of a container, the “APY” as the rate the container is growing, and the flow of funds as a tap filling the container with more liquid. The height of the liquid determines the market price for the token.
Let’s look at how the different rates of inflation and fund flow affect the token prices…
Using dark green blocks to represent new funds, we can see that if the rate of new funds equates to the inflation of the token supply, the price of the token remains the same.
If funds flow in at a rate higher than the rate where new tokens are introduced, the price of the token increases. This is where the demand for the token (from people willing to swap assets like DAI for the governance token) exceeds the supply (from staking rewards).
If the inflation rate exceeds the rate where new funds flow in, the price of the token falls.
Finally, if the fund stops receiving new funds (through bonding), the “APY” or inflation (through staking) will only be redistributing the value of the project and bringing the price down.
The problem with falling prices is that it sends a signal for a weak project and can send the project in a downward spiral if it persists for long.
Dynamic management of token inflation
Using the model you can see that if a project attracts a high level of funds during its initial stage of launch and the inflation rate is kept low, the token price can hike excessively and crowd out new investors.
On the other hand, for projects that have already raised huge treasuries, it cannot continue to expect a 100x growth in funds during the same time period.
Staking on Bluejay Finance
At Bluejay Finance, our policy is to make the protocol governance accessible to the mass while maintaining the purchasing power of the governance token through periods of high and low growth.
We intend to keep the APY for staking high during the initial launch period to ensure that new investors can get access to our governance token at reasonable prices as we go through a period of ultra-high growth in the initial stage as words spread about the protocol.
Once we have obtained a sizeable amount of treasury to deploy as liquidity for the different stablecoins and is expecting a slower flow of new funds we will adjust the APY down to maintain the price on a slower upward trajectory for all investors so that everyone can have stable and predictable returns when staking their BLU tokens.
The team will be monitoring the flow of funds and market sentiments to continuously adjust the APY or token inflation rate to ensure that they are in line with the prevailing monetary policy and keep token holders safe from excessive token inflation.
Stay Tuned
The protocol is still under active development and testing and we will be releasing our schedules and launch details soon. We are aiming to launch in May 2022 on the Ethereum mainnet.
As we get closer to launch, we will be releasing more details on the protocol and how you can participate.
Here are some ways you can get involved now:
[1] Technically the ceiling of the inflation rate assumes no other inflationary pressure (ie sale of bond that creates more governance tokens), since not 100% of the tokens will be staked for the APY.
Legal Disclaimer
The information provided in this Medium Post pertaining to Bluejay Finance, its crypto-assets, business assets, strategy, and operations, is for general informational purposes only and is not a formal offer to sell or a solicitation of an offer to buy any securities, options, futures, or other derivatives related to securities in any jurisdiction and its content is not prescribed by securities laws. Information contained in this Medium Post should not be relied upon as advice to buy or sell or hold such securities or as an offer to sell such securities. This Medium Post does not take into account nor does it provide any tax, legal, or investment advice or opinion regarding the specific investment objectives or financial situation of any person. Bluejay Finance and its agents, advisors, directors, officers, employees, and shareholders make no representation or warranties, expressed or implied, as to the accuracy of such information and Bluejay Finance expressly disclaims any and all liability that may be based on such information or errors or omissions thereof. Bluejay Finance reserves the right to amend or replace the information contained herein, in part or entirely, at any time, and undertakes no obligation to provide the recipient with access to the amended information or to notify the recipient thereof. The information contained in this Medium Post supersedes any prior Medium Post or conversation concerning the same, similar, or related information. Any information, representations, or statements not contained herein shall not be relied upon for any purpose. Neither Bluejay Finance nor any of its representatives shall have any liability whatsoever, under contract, tort, trust, or otherwise, to you or any person resulting from the use of the information in this Medium Post by you or any of your representatives or for omissions from the information in this Medium Post. Additionally, the Company undertakes no obligation to comment on the expectations of, or statements made by, third parties in respect of the matters discussed in this Medium Post.
