Team Proposal — PATHWAY: automated collateral management protocol
In this article, I present PATHWAY, a protocol for automated market making of DAO projects, and propose to put it into practice for Graviton treasury fund management.
Launching a tokenized project in the field of decentralized finance necesitates bootstrapping initial liquidity for the new token and keeping a large enough backing for sustainable and efficient market making. A multitude of such projects launch via a direct token sale or an initial DEX offering. In many instances, the project’s team itself is not willing to engage in market making, and it unfolds either organically (mainly on AMM decentralized exchanges) or with the involvement of market maker partners which are usually focused on liquidity and volumes on centralized exchanges. One way or another, the team or market making partners need to provide enough liquidity to support the tokenomics, in order for the project to succeed in the long run.
Share Repurchase (Buyback)
In traditional finance and the stock market, organizations can sell their securities to the market increasing the supply, and also buy securities back from the market decreasing the supply. These decisions are made by the boards of directors and are aimed at optimizing the balance sheets, capitalization or liquidity of the company.
In decentralized finance, a functional equivalent of an organization’s balance sheet is a “treasury” smart contract, which is usually either a simple multisig contract or a more complex structure that automates transactions of digital assets owned by the organization. Project’s assets aimed at covering operational and market-making costs can be stored in a treasury. An equivalent of shares in a decentralized organization is usually a token which allows its holders to influence product updates, smart contracts or protocol parameters. Such a token is usually called a “governance token” and its mode of operation has many parallels with the governance framework used by traditional organizations.
- Decisions on how to distribute assets to influence the token price (either directly or indirectly) often lack transparency and only serve the interests of a narrow group of people, which turns it into a lottery for most of the minority stakeholders
- The market for a particular asset can be manipulated to serve some hidden aims of the organization itself or its partners, and not the stakeholders or users in general
- Usually, when no proactive market making is being done on behalf of the project or its partners, the token becomes vulnerable to the natural movements of the market (bull and bear cycles) or to pump & dump manipulations
- Market-making usually lacks long-term planning and sets no expectations of project’s capitalization and growth trajectory
- DeFi Projects can use treasury funds as a market-making tool by simply selling the token to the market replenishing the treasury with a collateral (for example, in stablecoins), and then buying the token from the market using the collateral assets
- DeFi projects and their token holders can collectively define targets for project market capitalization on a one-two year timescale or other specified intervals, based on the assessment of similar projects in terms of market, ecosystem, investors, etc.
- Governance stakeholders can reconsider the capitalization target when new factors begin to impact the project, e.g. new products’ release, new partners, investors, market conditions, etc.
- These target trajectories of the project capitalization growth can be approximated algorithmically and followed through a system with feedback loops for calibrating/influencing the market price
- This automated system should be completely transparent, and third-party market makers or traders can follow its dynamics and synchronize, further neutralizing the attempts at price manipulation or spontaneous pumps & dumps
Treasury as an Automated Collateral
In this article of Graviton blog, the option of using Treasury funds as a collateral was proposed in order for the token to attain liquidity and create buyback pressure automatically by expending assets in the Treasury.
This approach is promising, however, its major effect is replacing the stablecoin collateral with LP tokens, ultimately leaving traditional and/or spontaneous market making strategies at play, the disadvantages of which are described above.
With PATHWAY, the treasury smart contract should not only regularly buy tokens from the market and put them in liquidity in the form of LP, but also monitor the current moving average of the token price, determining how far the current dynamics is from the trajectory agreed upon by the governance. The smart contract then buys the token if the deviation breaks the pessimistic corridor or sells it if the deviation is higher than the over-optimistic trajectory (“excessive pump” case). The buy and sell actions have conditional probability which will depend on the remaining amounts of collateral in the treasury, ensuring sufficient funds to achieve price stabilization.
The trajectory, which will reflect the desired evolution of the project’s capitalization in time, is determined by governance via voting for the parameters of a certain function (a superposition of linear, polynomial and exponential).
This function will describe an optimistic trajectory which the project and its community are striving to. However, in order to determine which actions of the algorithm should undertake to adjust the rate, some fuzzy over-optimistic and pessimistic boundaries are required to be set beforehand.
These boundaries are not clear-cut, but rather can be described as the sigma coefficient of the Gaussian function whose mean value is the optimistic estimate. The higher the average, the more overoptimistic is the capitalization dynamics, the lower — the more pessimistic. At every time step, this function has its own parameters, however, the further ahead in time, the greater the variance of estimates and the allowable interval of price volatility.
For instance, let’s assume the fully diluted cap for Graviton to be at $50 billion in three years and review a similar project, e.g. Chainlink, as a reference. However, it is important to note that the over-optimistic score should not be significantly higher than the industry leader BNB that went above 150 billion in three years. At the same time, we understand that if the project grows linearly, this will only lead to a pessimistic estimate of around $2 billion.
Thereby, when creating a forecast for the next one or two years through expert analytics and multisig voting, we can combine the basic functions and determine the most optimal parameters to generate a resulting PATHWAY function. The treasury smart contract will then attempt to follow this target trajectory and the team will be referring to the planned growth in operational tasks and sprints.
In order to stay robust to manipulation of trading bots, all decisions to buy or sell the token for a specific amount should be made in a non-deterministic manner, with a certain probability. For example, if the EMA of the GTON price is approaching the pessimistic zone, then the probability that the PATHWAY Calibrator smart contract will start to redeem the token from AMM Dexes should increase. Vice versa, if a pump occurs, the likelihood that the SC will sell more token increases. This scheme is probabilistic and gives no guarantees for the growth of the token or any other metrics, but rather, on average, statistically stabilizes the evolution of capitalization within the target values, leaving the natural volatility intact.
The market may evidently change, new partners or “celeb” contributors may enter the team, which may require a revision of forecasts and adaptation of PATHWAY parameters in accordance with the new conditions. This can be carried out through a regular consul/multisig voting that can take place once a month or several weeks.
I propose to the community to consider the PATHWAY algorithm as a foundation for automated market-making of GTON on decentralized exchanges. Below is the Graviton forum thread link to discuss the details of this proposal: https://forum.graviton.one/t/core-team-proposal-pathway-automated-collateral-management-protocol/24
Looking forward to community’s feedback!
Originally published at https://sapranidi.medium.com on May 19, 2021.