InstaLiq DAO is Introducing the World’s First Initial Liquidity Swap
At InstaLiq DAO, we are committed to providing a method to incubate tokens in the fairest way possible. We think that Initial Liquidity Swaps are an excellent method to stage such a fair launch and, as a Proof of Concept, we are seeking to launch our governance token (LIQ) using the very same method.
In this article, we want to detail how Initial Liquidity Swaps compare to other fair token launch methods. First of all, let us explain what we mean with “fair launch”. In order to determine the fairness of a token launch, we have identified seven factors:
Locked Liquidity
The most important factor for token-funded crypto projects is to gain liquidity somehow. During the heydays of Initial Coin Offerings (ICOs) in 2017 and 2018, the only way to achieve this was through listing the token on at least one notable centralized exchange, which often failed and led to the project being abandoned, even if the project was not planned to be an outright scam.
With the advent of Automated Market Makers (AMMs), decentralized exchanges became the get-go tool for gaining liquidity early on in the development of a project. The earliest examples of Initial DEX Offerings (IDOs) did not feature any liquidity lock-up, requiring secondary incentives such as liquidity farming. Also, this was prone to rug-pulls, as project creators had an incentive to simply terminate the project by cashing out all team tokens or LP tokens received.
As of today, the gold standard for IDOs requires project creators to lock up their LP tokens for a predetermined time frame. While this is a significant improvement, it just postpones the dreaded date after which project creators are able to either pull the rug, or remove a large part of the liquidity.
We believe that it would be a better approach to lock LP tokens up permanently. Initially, the idea was to simply send all of the team’s LP tokens to a burn address. This however creates a serious security flaw, in which the liquidity is unable to be migrated to a different AMM. Instead, the next best thing to do with LP tokens is to lock them up in a community-owned smart contract, only to be released upon a successful governance vote.
Automatic Price Discovery
Most token sale models are still reliant on the project team to determine a fair price at which to sell their tokens. This has several flaws:
First of all, team members don’t know their token’s fair market price themselves. This may lead to a token being overpriced at sale and the sale failing to reach the required soft cap. With enough hype, team members may also intentionally overprice the token in order to reap unjustified proceeds.
Even if the token is, either intentionally or unintentionally underpriced at sale, the outcome is not optimal either, since it allows whale investors to extract value from the eventual token users. In any case, the token is highly volatile as soon as it ultimately launches on a DEX, which can be avoided by having the free market decide on the initial listing value.
Meaningful Distribution
A crucial function of any token launch is to distribute an initial token supply to deserving holders. A 2019 essay by Alpine Intel called this a “meaningful distribution”. Ideally, all tokens should be distributed exclusively to stakeholders in such a way that it does not create a heavily centralized token allocation.
Token sale models are especially prone to becoming centralized, as whales are able to acquire large portions of the token supply, which both shuts out smaller investors and gives whales an unfairly high degree of governance power. While, nowadays, IDOs often restrict the amount of tokens that can be bought by a single address, these restrictions can easily be circumvented by using multiple addresses.
Initial Exchange Offerings (IEOs) typically put other restrictions in place to prevent whales from buying out large shares, but at the expense of a meaningful distribution. Oftentimes, participation rights in IEOs are granted to active traders, who are not core stakeholders of the final projects and often sell their tokens again after the launch. The same problem applies for airdrops that hand out tokens for free.
Recently, retroactive airdrops, such as the one conducted by Uniswap and Ethereum Name Service, have shown to lead to a meaningful distribution, as early adopters of a service are rewarded for their prior activities. However, this method has drastically reduced in usefulness as DeFi users have begun to perform wash transactions on protocols which are rumored to conduct a retroactive airdrop at some point in the future.
Oftentimes, these rogue actors even resort to Sybil attacks to increase their potential reward. To counteract this problem, platforms looking to perform a retroactive airdrop have started putting requirements in place for unlocking airdropped tokens. However, these requirements can easily become too restrictive leading to honest users being cut short of their rewards.
No-Sale Policy
Historically, token sale models have led to numerous scams and rug-pulls. The ability to instantly raise large amounts of funds without needing an actual product creates an incentive for project creators to take off with the sale proceeds, without delivering on their promise.
We believe that project creators should not profit directly from the proceeds of a token sale. Instead, they should come up with launch models that reward contributors for staying faithful to a project. This can be achieved through a team token allocation with long vesting periods, or a recurring remuneration for team members that is controlled by the community via governance votes.
Project Bootstrapping
A common desired side-effect of token launches is that they can be used as a fundraising vehicle to kick off the development of a project. This is not the case for IEOs and retroactive airdrops, since these methods require project creators to at least have a running MVP.
Projects relying solely on airdrops for token distribution have historically performed poorly in terms of token price, which severely limits the ability to fund project development.
Decentralized and Permissionless
We believe that the ability to launch tokens should be open to anyone. Unfortunately, the ability to raise funds without oversight also attracts scams and rug-pulls. This partially explains the popularity of IEOs, however at the expense of needing a centralized actor to vet projects. Many IDO platforms delegate this process to their community via governance voting.
At InstaLiq DAO, we plan to test out Instant Liquidity Swaps with a few selected projects, until ultimately switching to permissionless token incubation. At the same time, we are committed to establishing standard launch models that deter fraudulent behavior.
Comparison to Liquidity Bootstrapping Pools
So far, the most promising approach to market-driven price discovery we have seen is through Liquidity Bootstrapping Pools (LBPs), such as the one used by Balancer. While LBPs ultimately arrive at a fair market value once the LBP runs out, their very design puts early investors at a disadvantage, since tokens are placed on a descending price curve while the LBP runs.
A problem with LBPs is that they are still dependent on numerous parameters, such as an initial price, which have to be set (and paid for) by the launch team in advance. We think that Initial Liquidity Swaps can provide a simpler method for market-driven price discovery without putting early bidders at a disadvantage. Also, there is no need for an up-front investment by the project team.
LBPs have shown promising results in creating a meaningful token distribution, as their price curve deters whales from acquiring large token percentages. We hope that Initial Liquidity Swaps can recreate these deterring factors.
Suppose that, during the ILS period, market participants determine that a launching token is undervalued. This creates an incentive to correct the price upwards by entering more and higher bids.
If the market determines a token to be overvalued on the other hand, this creates an incentive to withdraw or reduce existing bids. It can be likened to a game of chicken: if all bidders refuse to reduce or withdraw their bids, all bidders will ultimately swap their bid tokens at an overpriced rate once the ILS period runs out.
This chicken game situation puts whales at a disadvantage compared with low-value bidders, since they have more at stake. Hence, whales are more likely to yield nearing the end of the ILS period when they feel that a token is overpriced.
Comparison to PinkSale Fair Launches
Another token launch model that has come up recently, which comes strikingly close to our idea of an ILS, is the Fair Launch feature introduced by PinkSale Finance. In fact, it is already possible to launch something akin to an ILS on PinkSale by setting the liquidity percentage to 100%, but we have yet to see this tried out in practice.
So far, most projects launching on PinkSale do not use the Fair Launch feature, relying on a fixed-price IDO model instead. Additionally, PinkSale allows for liquidity percentages as little as 51%, which still makes it possible to run various rug-pull schemes: project creators could either use their own token allocation to dump the token price, dump LP tokens once they unlock, or simply take off with part of their IDO or Fair Launch proceeds if the liquidity percentage is lower than 100%.
Another point about PinkSale Fair Launches that we find suboptimal is the 10% fee that is charged on “emergency withdrawals”. This creates a disincentive against withdrawing bids, which negatively affects price discovery. We believe that investors under the ILS model should be allowed to partially or fully withdraw their bids at any time if they believe that the token is overpriced at any point during the ILS period.
While PinkSale’s Fair Launch model is a huge step forward, we think that its full potential for aspiring crypto projects has not been achieved yet. We invite the PinkSale community to collectively work on improving this token launch model and establishing Initial Liquidity Swaps as a gold standard for incubating tokens.
