Power Tokens — A new Tokenomics Template [Part 2]

I got the power

This is Part 2 of our series on Power Tokens. Before continuing, make sure to read Part 1.

Power Tokens Deep Dive

Goal #1: Alignment of LPs, stakers and the protocol

The first step to alignment is getting LPs to care about the protocol and governance. This can be done via a retroactive airdrop or liquidity mining. How effective this initial distribution is in onboarding the right people depends on the design of the chosen mechanic. We recommend unannounced retroactive airdrops, as these allow projects to test product-market-fit without a live-token, increases the chances of onboarding non-mercenary community members) and optimize the token distribution based on historical data. A retroactive airdrop should be followed by other means of distributing tokens, as otherwise new community members may be hesitant to join due to feeling like they missed out. People entering the community later can become valuable members as well. Therefore, they should be motivated to contribute and be given governance power too.

For example, one can run a liquidity mining program after the airdrop. At Deus Ex DAO, we also like the idea of doing multiple retroactive airdrops over time, given the mercenary capital liquidity mining programs attract. Inclusion criteria can be broader than simply provided capital, for instance by targeting important governance or community participants.

Liquidity mining programs can be optimized to reduce the “harm” done by mercenary capital. Teams may want to give stakers a multiplier on LP rewards, boosting returns for LPs that haven’t sold their (airdropped) tokens.. This is only advisable when the airdrop distribution has been broad enough (as such a multiplier concentrates supply among existing holders) and filtered most bad actors.

Aside from token distribution, communication is essential in conveying a long-term mission to the community they want to contribute to, and aligning stakeholders. Financial engineering can only influence people’s motivations to a certain degree.

So, while power tokens themselves do not automatically lead to long-term alignment, they have great potential as airdrops, liquidity mining programs and governance can be designed flexibly on top. Ve-tokens fix the staking, liquidity mining and governance logic. Power tokens are more like a blank canvas. They allow teams to add their own ideas to optimize for different goals.

IPOR brings some neat ideas about what a potential future could look like. LPs are rewarded directly with power tokens instead of unstaked tokens. First, as power tokens have a 14 day withdrawal period, this essentially adds reward vesting. It also eliminates longer duration lock-ups, as has been popularized by ve-tokens. Moreover, it introduces LPs to staking, reducing the steps (and transactions) required to earn an LP reward multiplier, thereby showing people the value of the token which potentially reduces sell pressure.

An open question remains how aligned the onboarded governance participants and LPs will be. This will depend on the governance and reward modules built on top of power tokens. Power tokens themselves provide a neutral foundation. As they don’t come with a mandatory lock-up, the issues of meta governance and governance halt described for ve-tokens do not apply.

Goal #2: Natural price discovery

With no token lock-up and short withdrawal periods (e.g. 14 days in IPOR’s case), tokens can be repriced consistently may have larger trading liquidity than the boom-and-bust cycles caused by large, sudden supply shocks (sharp increase or decrease of circulating token supply) as seen with ve-tokens.

IPOR further allows stakers to exit before the cool-off period ends for a small penalty which is distributed to remaining stakers. While rewarding loyal stakers, this could result in sudden sell pressure in case of negatively interpreted news, for example. The balance sought is between:

1. Treating stakers as first class citizens. Stakers use tokens as intended by the protocol. They shouldn’t have a big disadvantage compared to token holders. This also means allowing them to exit when they want.
2. Decreasing price volatility. While consistent repricing in the market is preferable to long periods of ineffective markets, there’s also merit in managing price shocks, as exemplified by circuit breakers in stock trading. This is especially the case for new information whose impact is hard to evaluate at first. Supply reduction (like in buyback-and-burn) can also be an effective tool to support price.

Goal #3: Broader token distribution

A wide base of token holders brings the following advantages

• More community members which are incentivized to contribute. For complex tasks, teams have a higher chance of finding a fitting contributor among a larger group. For easy tasks which require no specialized skills, such as providing feedback, projects can query more voices, which improves chances of getting significant results.
• Token price is less reliant on a few actors, which can potentially make or break a project. Broader distribution of tokens means less concentration in the hands of whales.
• More decentralized governance. Better resilience against governance attacks, higher participation rates as small holders can make a difference, and better representation of users within governance.

IPOR introduces a logarithmic multiplier curve to its liquidity mining module. The logic is the following: The more pwIPOR tokens a user delegates to a pool they provide liquidity for, the higher the rewards. But, the additional rewards a user can earn this way decreases the more tokens are delegated, given a fixed amount of liquidity provided in the pool. In essence, the reward curve depends on the ratio of delegated tokens compared to the provided liquidity.

That changes the tradeoff calculation of stakers. In a linear liquidity mining model, every token staked adds an equal amount of future tokens as rewards. In the logarithmic model, the last staked token receives less future tokens then the tokens staked before. As a result, selling some tokens becomes more attractive as the utility of additional tokens decreases.

We expect this results in token hoarding at the beginning of liquidity mining, followed by selling by a concentrated holder base, to be less of an issue. How it could play out is LPs selling tokens more consistently, distributing sell pressure over time, and allowing newcomers to scoop up tokens at a fair price. We could see LPs selling token rewards and adding them as liquidity to maximize their rewards, while boosting TVL.

As tokens move from users with a high stake-to-LP ratio to users with a lower stake-to-LP ratio, the token multiplier (can also be seen as the token utility or productivity) across stakers increases. If the total amount of liquidity mining rewards per epoch is set beforehand (and therefore capped), which usually is the case, the overall token utility across stakers is set from the start and cannot change. What changes is how the rewards are split among stakers. In a linear model, a staker would lose APR proportional to the amount unstaked, while the buyer of the tokens would win an equal amount of APR (measured as token rewards per LP). A logarithmic curve reinforces the changes, meaning the seller loses more and the buyer wins more APR, leading to closer APRs between stakers.

In contrast to a linear model where a staker’s APR depends on the total amount of tokens staked, it also plays a role who the other stakers are (their staking-to-LP ratios), in the logarithmic model. The more stakers with a high staking-to-LP ratio sell and the more stakers with a low staking-to-LP ratio buy and stake, the lower the APR of a hoarder becomes. Therefore, the incentive to sell some tokens increases over time.

When the price of the token changes, it affects the calculations to maximize returns. If the token price increases, a staker can trade more other tokens (for example, stablecoins) for them. Providing these other tokens as liquidity (for example, adding liquidity to the USDC pool on IPOR) now has a stronger impact on the received liquidity mining rewards, making such a decision more attractive. If token price decreases, buying tokens becomes more attractive. The APR arbitrage between liquidity provided and tokens staked can be seen as a price balancing mechanic.

Note: Assumes that stakers are indifferent between various tokens, for example IPOR and stablecoins, and are only looking to maximize future returns and do not speculate on token prices.

Ipor intern created a spreadsheet to make designing a staking strategy for liquidity mining easier.

Comparison with other token models

Let’s compare power tokens to ve-tokens to tokens which use a time boost mechanic, such as GMX. There, stakers accrue multiplier points over time and the maximum multiplier is capped.

How’s the lock-in incentivized?

• For ve-tokens, there’s a strict logic embedded into the protocol which doesn’t allow for unstaking during the lock-up period. Moreover, longer locks are incentivized with higher rewards.
• In GMX’ implementation of time boosted staking, there’s a soft incentive for stakers to stay staked. When a user unstakes, they have the opportunity costs of losing their multiplier on future rewards. Additionally, their accumulated token incentives must be vested over time to become liquidly tradable. Stakers who initiate vesting will no longer earn rewards on the tokens deposited for vesting, adding another opportunity cost. Users must stake sufficient non-escrowed GMX to allow for vesting of the esGMX they intend to vest over 12 months. They can unstake early, but then forego accumulated token incentives (again, opportunity costs). A user can re-purchase and stake GMX on the open market to resume vesting of their esGMX however.
• In IPOR’s implementation of power tokens, the primary incentive to remain staked is to boost one’s LP rewards. There’s a brief redemption period of 14 days to unlock, with a 50% penalty to unlock early. There are no vested rewards and thus the incentive to stake is positive (increase rewards) instead of negative (lose escrowed tokens). Thanks to its modular design, teams can experiment with the power token model, and, for example, add reward vesting.

Since power tokens don’t make use of opportunity cost mechanics, they do not favor early stakers as much. Time boosted models give benefits (APR boosts) to long-time stakers, which can deter new capital and users.

Power tokens as a token template do not come with an embedded governance logic, meaning projects have to add their own governance module and make changes to other modules (e.g. add vesting to the rewards module) to align voters with the protocol and its stakeholders. Without a lockup period, the governance power associated with power tokens can easily transfer to new token holders, in contrast to ve-token models where they may be locked for years.

Future considerations

In the end, the actual effects of power tokens depend on the case-specific implementation. Due to its modularity, we can expect different designs, catering to different products, business goals, and token utilities. The design space is broader than for ve-tokens.

For instance, a team may want to increase the multiplier given by staking. This impacts the trade-off decisions users have to make. As the same staking-to-LP ratio now gives a higher multiplier, it becomes attractive to hold more of the token as it has higher utility compared to the template model. This may result in a higher holder concentration.

The effectiveness of changes, reflected in the shape of the multiplier curve, will depend on how much people care about token utility (maximizing APR) versus speculating on token price. It will be interesting to see how the market will react to the power token model.

Like ve-tokens, the power token model must be enhanced with utility by teams and their communities. Maximizing liquidity mining rewards won’t be sufficient. Providing governance power, a share of profits or social standing may increase a token’s usefulness. The benefit of the power token template: It can be expanded over time due to its modularity. For example, IPOR’s power tokens’ first utility is to broadly distribute their token by boosting rewards of LPs. Over time, we expect additional utility to come via governance, and so on.

Lastly, we are looking forward to teams using the logarithmic multiplier curve on liquidity mining of non-stable assets. This changes the user’s decision-making as now both the staked and LPed tokens have a variable price. A fun financial game that we envision being adopted by many future projects to add balanced token utility.

Conclusion

Power tokens are a new tokenomics template which bring flexibility to projects who can optimize their token model according to their goals. As a template, power tokens are not opinionated on topics (e.g. governance), but rather give a blank canvas that teams have to fill.

The logarithmic multiplier curve for reward distribution introduced with power tokens is an exciting new primitive which drives broader token distribution. This promotes participation and decentralization of a protocol. Power tokens are a new primitive that can enhance the functionality and scalability of various decentralized projects. We look forward to seeing how this tokenomic model is adapted across the community and which iterations will spawn.