Presenting the LYDRA/HYDRA Liquidity Strategy Proposal
The official proposal thread can be found below. Please leave your comments in the DAO forum, so that they don’t get lost:
This post outlines the proposed strategy for the launch of the LYDRA/HYDRA liquidity pool.
Rationale
The launch of the LYDRA/HYDRA pool will be an important milestone for the Hydra ecosystem and usher in a completely new era for the network. As such, it is important to think about the liquidity strategy and analyze its effects with care.
The main objectives of the strategy are defined as:
- Achieving a strong liquidity depth that would allow network participants to execute high-value trades with little slippage
- Minimizing unfair situations where one or few individuals take advantage of a preferential rate at the exact moment of deployment, just because they managed to make the trade a few seconds faster
- Mitigating the risk of HYDRA being dumped due to an artificially elevated rate
- Ideally, achieving a net deflationary impact on HYDRA via lockup of initial HYDRA liquidity as part of the launch
- Allowing market forces to go into an unbiased price discovery and open up opportunities for leverage and hedging opportunities
Note: These objectives will be referenced by their numbers in the following sections of the proposal.
Note: For the purpose of this proposal, we define the “price ratio” as the ratio between the LYDRA price and the HYDRA price. For example, if LYDRA is priced at $0.50 and HYDRA is at $1.00, then the price ratio will be 0.50/1.00 = 0.50.
It is crucially important to emphasize that the pool deployment will take place via the DAO treasury and as such should ensure that no artificial inflationary impact arises as a result of the pool deployment.
Introducing the Proposed Strategy
To discuss the strategy, we will first explore considerations about the starting price ratio, then look into the deployment of strategic liquidity ranges and finally present you the resulting calculations.
Starting Price Ratio
Since LYDRA is a completely new asset with no previous trading or price history, it is important to be careful when defining the starting price ratio. If the starting ratio diverts too far away from its “fair market ratio”, then it will result in a few lucky traders to cash in the difference — at the expense of everyone else.
This is why objectives 2) and 3) were put in place.
If the starting ratio is set too high (well above its fair rate), it would present an opportunity for some traders to take advantage of the disparity “for free”, essentially cashing in a risk-free trade just because they were a few seconds faster than everyone else.
Such a situation would not only waste valuable resources, but also potentially incentivize network participants to dump their newly received HYDRA.
For example, imagine that the price ratio started at 0.8, meaning that 1 LYDRA is worth 0.8 HYDRA. Since we don’t know the fair market ratio yet, this exposes the pool to certain risks. If the fair market ratio ends up at 0.5, then this situation would essentially incentivize network participants to dump their holdings in a race against each other.
Or in other words: Sell artificially expensive LYDRA -> Receive a leveraged amount of HYDRA -> Sell HYDRA and/or Stake HYDRA
This is so because the theoretically possible range for the price ratio is between 0 and 1. Therefore, a 0.8 rate (being on the higher end) would be perceived as “low risk” for LYDRA liquidation and essentially translate into a free lunch for the fastest traders. Since everyone would know about this, it could result in a race of who takes advantage first, potentially spilling over the selling pressure to the HYDRA/USDT pairs as well.
And since the initial liquidity of the pool would be deployed via the DAO treasury, it would result in a net inflationary impact on the existing circulating supply of HYDRA. This is so because the deployment of the pool would actually almost immediately release part of the HYDRA after the launch in the form of very low-risk leverage.
Because of the factors outlined above, launching with a too-attractive starting price could cause a negative event which should be avoided.
The goal should be to avoid an artificially high starting price and enable the pool deployment to be a net positive event.
The question then becomes: How do we ensure this?
Given that we don’t have any history for LYDRA, we can’t really know what its fair price will be. In theory, it could be anywhere between 0 and 1.
One may assume that the fair price should be somewhere in the middle.
Considering the objective to lockup HYDRA from the network into the pool, it makes sense to target a ratio that is below the fair price.
This approach is also to some degree universally validated by the vast majority of successful projects. Starting from a lower-end price in a public launch and allowing the market to determine the fair price.
This way we will not only mitigate risks towards a “race of dumping”, but also potentially lockup HYDRA, causing a net deflationary impact in the short term.
Launching at a below market rate, would not only stimulate activity, but also take advantage of the abundance of liquidity in the form of HYDRA.
This will also enable the market to open up its own leveraging and hedging opportunities, in a fully natural way that is sustainable, as opposed to a single-time artificial window of opportunity. As the pool would lock-up HYDRA in the process of moving the price ratio upwards, these same HYDRA would become available for leveraging and hedging.
Thus making it possible to engage in those actions by using already existing HYDRA that were in circulation before, as opposed to introducing new HYDRA from the DAO treasury.
This way, the lower starting rate also makes it possible to enable market forces to go into an unbiased price discovery.
Considering all the above points, we want to propose a starting rate of 0.3 HYDRA/LYDRA. This would apply a slight incentive for network participants to lockup HYDRA and at the same time let the pool start from a position of strength, allowing for a fully organic price discovery and protecting against the risks of a few lucky participants dumping on a race.
The lower starting price will achieve something similar to the liquidity event HYDRA was initially launched with.
Ratios below 0.3 were ruled out as they would have yielded an insignificant improvement in terms of HYDRA lockups, in exchange for a significantly higher LYDRA release. This can be observed visually in the above graphic.
Liquidity Ranges
Now that we know where to start, we can construct strategic liquidity zones that would aim for high liquidity depth, especially in the areas that matter most.
What are liquidity zones?
Liquidity zones aim to distribute the liquidity into several strategic areas, which is possible thanks to the modular design of V3 Hydra pools.
LYDRA allows for a unique opportunity for optimizing liquidity, since its theoretical range is limited to 0–1 and there is a known risk gradient across the range.
For example, if the price ratio comes too close to 1, this will open up a risk-free leveraging opportunity that can be captured by any network participant instantly. Therefore we know that although prices may occasionally come close to this ratio, they will likely not sustain for long. We can also be sure that at high ratios, plenty of reserve liquidity will be activated from network participants who want to take advantage of it.
Therefore the passive liquidity on the higher ranges can be given a lower weight.
We also know that as the price ratio comes closer to 0, it would become increasingly risky (and inefficient) for leveraging and hedging strategies to be executed, therefore making it increasingly difficult to sustain the LYDRA sell pressure. Speculators and investors would also increasingly be attracted to purchase LYDRA at low ratios, as LYDRA is always backed 100% by HYDRA and hence would offer a very good risk/reward for an entry.
Therefore the passive liquidity on the lower ranges can also be given a lower weight.
Based on the above elaborations, we propose the following liquidity distribution that focuses on the core range of 0.3–0.7 and supplements it with two additional ranges around it. The areas of <0.2 and >0.8 will have lowest depth as they will likely not be visited as often as the middle ranges.
We also propose the weights to be distributed based on a seeding liquidity of 1M LYDRA, to be made available by the DAO Treasury, which currently sits on roughly 4M HYDRA. The resulting LYDRA allocation is shown in the 3rd column below:
Calculating the corresponding HYDRA that is needed to seed the pool at the starting ratio of 0.3, we arrive at the following numbers (based on the V3 DEX formula):
Therefore, the liquidity pool would be seeded with a total of 1M LYDRA + ~173,000 HYDRA.
Let’s now observe how the pool liquidity develops under a hypothetical price ratio of 0.5. For this, we simulate LYDRA purchases from the pool, starting from the 0.3 rate and ending up with 0.5. Below is the result:
Using the 0.3 starting price scenario, and simulating trades towards a price ratio of 0.5, the liquidity composition inside the pool would end up with:
380k HYDRA + 467k LYDRA (see above table)
Notice that this essentially resulted in a lockup of 207,000 HYDRA inside the pool. While in return it released 533,000 LYDRA, that should not cause much of an impact, given that it comes as the result of the LYDRA price finding its organic equilibrium. Also the LYDRA circulating supply is expected to be smaller than HYDRA, as not everyone will be comfortable with utilizing their LYDRA (risking their locked up HYDRA in the process). After all, only the LYDRA that are moved out of their origin addresses will be contributing to its economy.
After the launch, the balances of HYDRA and LYDRA inside the pool will dynamically change in accordance with the price ratio and fees collected over time. The higher the ratio, the more HYDRA will be locked up and the lower the ratio, the more LYDRA will be locked up.
In accordance with the Hydra 2.0 whitepaper, the pool will be deployed with an initial 1% fee setting, which would gradually take out both HYDRA and LYDRA supply from circulation. For example a single 1,000 HYDRA swap would take out 10 HYDRA. The high fee setting with the range bound impermanent loss should also make Liquidity Pool provisioning a fairly attractive activity on its own, further attracting circulating HYDRA into the pool and further stimulating deflation. The fee setting could be modified by the DAO in case a more optimal solution is proposed.
In the coming days, we will be putting forward additional proposals around the LYDRA economy and the liquidity mining campaigns that will fuel it. As they scale, demand for LYDRA should also increase.
Important Notes
The 0.5 ratio simulation shared above is meant to illustrate the lockup dynamics based on one of many possible scenarios. There is no specific expectation or requirement for the rate to end up or stay there, especially since it will be changing dynamically every day based on market forces.
Although the proposal assumes the ratio of 0.3 to be below the equilibrium market rate at the moment of the launch, there is no guarantee for this to be the case. However in either case it should serve its purpose of a smooth launch, as it meets all 5 objectives and ensures a safe launch procedure.
Summary of the Proposal
- Deploying a LYDRA/HYDRA pool with the starting ratio of 0.3
- Seeding the pool with 1M LYDRA + 173k HYDRA from the DAO Treasury, ensuring no inflationary impact for HYDRA happens and facilitating an attractive launch event for LYDRA
- Using a V3 DEX pool that would allow for the 3 strategic liquidity zones outlined above
- The pool to be deployed with a 1% fee setting, in order to reduce the circulating supply over time and to further stimulate LPs to deploy both their HYDRA and LYDRA into the pool
Please make sure to leave your comments in the official proposal thread within the DAO forum. This will ensure that your remarks won’t get lost on other channels and that everyone who reads through the proposal in the future will be able to find it easily.
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