The New L2-Compatible KLAYswap Strategy Plan

Hello, KLAYswap community.

This post details the $KSP inflation distribution and the related governance for the L2-compatible version of the KLAYswap protocol.

The existing KLAYswap focused on building a single Klaytn ecosystem. However, the newly released L2-compatible version, taking another step forward, is an open source-based decentralized protocol with open governance that can be combined with various DApps.

The launch of L2-compatible version governance is a strategy for the continuation of the protocol in the KAIA network.
Ultimately, the launch is aimed at securing liquidity faster than competitors once entering Silicon network, where competition is expected with multiple DEX protocols, and growing into an integral Web3 protocol.

To achieve this goal, KLAYswap has introduced a new $KSP inflation distribution and governance structure. This will lead to a strong increase in user inflows and liquidity inflows, increasing its competitiveness.

4-Split $KSP Inflation Distribution

*Main Changes

- 4 categories of $KSP inflation distribution: Supply & Borrow(5%), Pair(10%), Staking(65%), Ecosystem(20%)

The existing KLAYswap distributed $KSP inflation to KLAYswap ecosystem participants in three categories. The L2-compatible KLAYswap distributes inflation across four categories, namely Supply & Borrow, Pair, Staking, and Ecosystem. As such, the KLAYswap team will allocate 5% for Supply & Borrow, 10% for Pair, 65% for Staking, and 20% for Ecosystem through governance for the initial distribution of each category. This percentage can be changed in the future through the governance DAO.

1) Supply & Borrow

* Main Changes

• Supply & Borrow service launch
• $KSP inflation distribution for Supply & Borrow (5%)

KLAYswap’s Single Pool liquidity was utilized for Leveraged Yield Farm, where liquidity was provided directly to the pool. With the ‘Supply & Borrow’ feature, participants can freely acquire assets from one another, allowing them to participate in a variety of ways (re-supply, sell, etc.).

* Detailed information on Supply & Borrow will be available through the L2-compatible version KLAYswap introduction.

Providing liquidity by leveraging assets in the Supply pool expands pool liquidity within KLAYswap (increasing TVL), and more liquidity increases the amount of trade. It also allows for more flexible long/short positioning, which allows L2-compatible KLAYswap versions to offer more asset leveraging functions.

The diversity and scale of the assets initially supplied to the pool is essential to generating meaningful trading volume and vitalizing the protocol. The L2-compatible KLAYswap will offer pools with a wider variety of assets, including Wormhole bridge assets, and will distribute 5% of the $KSP daily inflation so that rapid liquidity can be provided, ensuring smooth asset supply as soon as the feature is live.

Aside from encouraging an increase in single-asset liquidity, this adjustment also encourages the overall activation of L2-compatible KLAYswap’s various services, thanks to its abundant liquidity.

2) Pair Supply

* Main Changes

• $KSP inflation distribution for Pair Supply (10%)
• Pool Usage Fee distribution structure change: Liquidity provider(80%), $KSP buyback(10%), vKSP holder(10%)
• Updated $KSP distribution policy for pairs: Distributed based on buyback contribution (100%) (excludes Pool Voting, Token Level, and Pair Weight)

To create a safe and efficient environment for trading tokens, KLAYswap distributes $KSP rewards to liquidity providers (LP). In L2-compatible KLAYswap, liquidity providers will be rewarded with 10% of the daily $KSP inflation, and pool usage fees distribution structure and $KSP distribution policies for each pair are as follows.

Existing Version

1. vKSP holders receive 50% of the V2 pool usage fees, and $KSP holders receive 50%.
2. Liquidity providers receive 40% of V3 pool usage fees, vKSP holders 30%, and 30% is used for $KSP buyback.
3. The distribution of $KSP to each pool will be based on buyback contributions (50%) and Pool Voting (50%).
4. The distribution of $KSP to each pool will be applied by token level and a weight of each pair accordingly.

L2-Compatible Version

1. A total of 80% of pool usage fees generated by the V2 & V3 pools will be distributed to liquidity providers, 10% automatically distributed to vKSP holders based on their stake ratio, and the remaining 10% used for $KSP buyback.
2. The $KSP distribution is based on the buyback contribution of each pool (100%).
3. When distributing $KSP to each pool, token level and pair weight will not be applied.

This strategy intends to mitigate the $KSP selling pressure and nonlinear liquidity pool reward distribution caused by the existing pool usage fee distribution structure.

Instead of distributing the majority of pool usage fees to $KSP governance (vKSP pool voters, $KSP buybacks), the existing pool usage fee distribution structure distributed $KSP to liquidity providers. In the early stages of KLAYswap’s growth, this structure worked well. It encouraged liquidity providers to supply more liquidity which fuelled rapid growth of KLAYswap.

However, while this structure distributes $KSP to the majority of liquidity providers as rewards (APR), it also has its limitations, since it creates constant selling pressure and undervaluation as earned rewards must be continually sold to realize $KSP.

Moreover, the combination of this pool usage fee distribution structure, token level weighting, and per-pair voting elements have resulted in an inability to linearly correlate pool liquidity contributions (trading volume) with $KSP rewards distributed to the pool.

The chart above shows the percentage of rewards distributed to each KLAYswap pools in H2 2023 based on each pool’s trading volume. X-axis is trading volume ($) and Y-axis is reward ratio by volume (pool distributed rewards/fees generated). Values greater than 1 on the y-axis indicate that the liquidity provider is taking a greater percentage of rewards in comparison with the fees generated by the liquidity pool. While values less than 1 indicate that the liquidity provider is taking a lesser percentage of rewards in comparison to its fees. This example illustrates how, as the trading volume increases, a lower percentage of rewards than the pool generates through its fees can be earned.

Because of the non-linear reward distribution, liquidity pools that contribute more to $KSP and the KLAYswap protocol are not sufficiently rewarded, which leads to lower TVL and weaker volume generation across the entire protocol.

However, the L2-compatible KLAYswap protocol has its own pool support structure, using pool usage fees, which rewards liquidity providers for their participation and contribution to the protocol. Because liquidity providers receive additional $KSP rewards with selling pressure alleviated, they are also encouraged to continuously provide liquidity to L2-compatible KLAYswap. Based on the updated inflation policy and pool usage fee distribution structure, L2-compatible KLAYswap aims to activate the protocol within the KAIA ecosystem, as well as compete with other Ethereum DEXs as it scales and enters L2.

Having analyzed the expected rewards for liquidity providers under the strategy, a model that enhances the distribution of rewards based on trading volume with little change to the rewards earned by liquidity providers has been developed.

Here is the table of the estimated daily rewards of liquidity providers for the existing period, the post-reorganization period, and the post-halving period based on KLAYswap’s trading volume data for the second half of 2023 and Q1 of 2024 (Feb-Apr). As can be seen, the rewards for liquidity providers have remained the same or slightly increased.

3) Staking & Pool Voting

*Main Changes

• $KSP inflation distribution for staking (65%)
• 10% of the total pool usage fee will be utilized for $KSP bayback and distributed in $KSP based on each user’s vKSP share (fee distribution changes based on pool voting)
• Ecopot and Drops functions will be offered through Quickstarter (tentative name)

With the L2-compatible KLAYswap, a 65% of daily $KSP inflation will be distributed to vKSP holders, who contribute to the protocol, to strengthen the reward structure and encourage the continuous staking.
Moreover, this structure is not designed in a way that vKSP holders receive a share of the pool usage fees generated by Pool Voting, but rather an allocated percentage (10%) of the pool usage fees generated by the entire liquidity pools. This percentage(10%) is the percentage of $KSP buyback from pool usage fees and will be automatically distributed to vKSP holders based on their stake ratio. As a result, for the L2-compatible KLAYswap, Pool Voting, Token Level, and the weight of each pair will not be taken into account when distributing rewards.

Rather than rewarding vKSP holders with a percentage of pool usage fees, existing Pool Voting rewarded liquidity pools based on the percentage of vKSP votes. It was designed this way so that pools that generate a lot of pool usage fees would naturally attract users’ votes, which in turn would distribute more $KSP to those pools, thereby activating them. Initially, the Pool Voting process was thought to create a virtuous cycle where pools with the highest pool usage fees were rewarded with more $KSP and contributed more to the protocol’s growth. However, the introduction of the Pool Voting system resulted in ‘A Fixation Phenomenon’, which caused a constant problem, namely that wallets voted according to their personal preferences disregarding pool usage fees.

With this Fixation Phenomenon, Token Levels, The Weight of Each Pair, and other factors combined, it was difficult for liquidity pools with high pool usage fees to earn adequate $KSP rewards. As a result, new liquidity pools that help the protocol evolve, which is vital for its continued growth, face a barrier to entry.

* Note: Approximately 66% of wallets that staked 1,000 $KSP or more in April 2024 have not performed voting-related activity in the past month.

The distribution with L2-compatible KLAYswap is intended to accomplish the following.

Firstly, L2-compatible KLAYswap can build a more open liquidity environment by distributing rewards to liquidity pools solely based on pool usage fees, the most objective and direct indicator of protocol contribution. As a result, entry of more and new liquidity pools can be anticipated, which will lead to rapid increases in protocol trading volume and liquidity. Furthermore, active participation in the new vKSP staking can be expected, since vKSP holders will receive proper rewards based on their stake ratio without a complicated Pool Voting process.

4) Ecosystem

*Main Changes

• Addition of broadly conceived common funding items voted on by vKSP holders to revitalize the Protocol
• $KSP inflation distribution to the Ecosystem (20%)

This L2-compatible KLAYswap will have an “Ecosystem” section, which is a comprehensive resource for the vitalization of the ecosystem, distributing 20% of the daily $KSP inflation.

In order to compete with other DEX protocols, not only within the KAIA ecosystem, but also within the Ethereum L2 ecosystem, KLAYswap requires fast liquidity inflow in terms of diversity and scale. As such, a strategy that encourages immediate liquidity entry and activation requires public resources to be available in a variety of forms — creation of KSP pairs, liquidity pools, pool boosting, marketing, listings, Treasury, etc. $KSP allocated as ecosystems are transparently managed through contracts, and only enforced by DAO voting when necessary. Any benefits from the utilization of Ecosystem volume, which is public resources, will be used to burn $KSP through $KSP buybacks and to reward vKSP holders.

Following the opening of the L2-compatible protocol, DAO discussion and voting will determine how the ecosystem is utilized. The following ideas, for instance, could be used to automate the activation of $KSP pairs.

[Example] $KSP Pair Activation

KLAYswap has consistently implemented policies that put $KSP assets in the highest level of token level and pair weight, as well as giving the highest weight to $KSP-related liquidity pools since the introduction of governance to vitalize the $KSP ecosystem. By creating pairs that provide favorable rewards, for the vitalization of $KSP ecosystem, it is expected to create a virtuous cycle by “activating $KSP liquidity pair trading volume > increasing $KSP rewards through $KSP buyback contributions (increasing reward rate) > expanding $KSP liquidity supply”. This also leads to a stable circulation of $KSP and a maximized utilization of $KSP. Due to the absence of additional incentives, however, new liquidity found it difficult to voluntarily secure $KSP volumes to create and activate liquidity pools. Furthermore, the persistently low reward rates also made it difficult to activate liquidity pools. Through the utilization of the DAO’s public resources, the ecosystem volume ($KSP), it is expected to create and activate $KSP pairs with assets that generate a high volume of transactions. This will not only result in the distribution of the rewards generated by the pools to the DAO, but will also contribute to the activation of the entire protocol and $KSP. Thus, the ecosystem can be utilized as follows.

1) Decide on tokens(new liquidity assets) to be paired with $KSP in L2-compatible KLAYswap through DAO voting, and supply DAO’s ecosystem volume ($KSP) and the project or foundation’s asset volume to create a liquidity pool through the contract. (Utilizing the auto-supply service (tentatively named) that will be opened when the liquidity pool is created.)

2) In order to facilitate the rapid inflow of liquidity into the liquidity pool created through collaboration, some portion of ecosystem volume($KSP) will also be utilized for the $KSP airdrop in the pool over a certain period of time. Pool usage fees and $KSP rewards earned from ecosystem pairs will be split 50:50 between the $KSP DAO and the foundation supplying liquidity. After that, 50% of the DAO’s rewards will be used for $KSP butback, and 50% will be distributed to vKSP holders.

Using ecosystem volumes this way not only reduces the initial resource burden for new foundations to create liquidity pools paired with $KSP within L2- compatible KLAYswap, but also encourages the influx of more holders of $KSP and foundation’s token to create meaningful liquidity and trading volume quickly through initial incentives. This strategy will help secure a unique business model and enhance competitiveness within the KAIA ecosystem and the L2 ecosystem. In addition, through this utilization of ecosystem, $KSP’s utility will be increased through the activation of $KSP pairs, which in turn will increase its demand on the market, resulting in the creation of additional rewards for vKSP holders and active DAO participation, which will ultimately lead to activation of the entire ecosystem.

On the assumption that 50% of the ecosystem volume is utilized, the protocol’s liquidity and protocol usage fees are as follows.

General

Changes in $KSP buy/sell pressure

This is an overview of the changes in L2-compatible KLAYswap buying and selling pressure.

The major feature of our L2-compatible KLAYswap is the reduction in liquidity provider rewards, which is a selling pressure. The $KSP buyback, which is the buying pressure, will also be reduced, but by a smaller amount to avoid the current situation where the buying pressure is much smaller than selling pressure. Despite the difficulty of obtaining the exact buying-selling pressure, here is the simulation of what it would look like in this case.

The table above shows the projected buying-selling pressure at each of the major $KSP prices based on trading volume in 2023’s third and fourth quarters. Clearly, the new strategy imposes a much higher level of buying-selling pressure than the previous one. Since not all liquidity providers sell the $KSP they receive, we can expect the actual equilibrium price to be higher than the table above. In the second half of last year, $KSP’s actual price was between $0.5 and $0.7, above the equilibrium price of $0.3 to $0.4 in the table above.

A similar trend can be easily observed in Q1 2024, when trading volumes were relatively low. There may not be much change immediately after the alteration, but over time there will be much more buying pressure.

• vKSP Holders’ Reward Change Chart

The reward structure for vKSP holders will also change as a result of this change. The following is a calculation of the daily reward per $KSP price for vKSP holders based on last year’s second half data. (including liquidity pool creation)

Despite the variations in $KSP price, the table shows that the reward for the new version is almost the same as the existing version for most of the interval before the halving. In fact, the reward increases as $KSP increases in price. Following the halving, there is a reduction in reward at sections with lower $KSP prices. Nevertheless, as the price of $KSP increases, the reward becomes higher than the existing version. Consequently, it appears that the reward will increase as the value of $KSP and the price increase.

This was the introduction of the $KSP inflation allocation and governance for the L2-compatible KLAYswap protocol.

These changes are the result of a long-term analysis of our existing version and the necessity to adapt to the changing ecosystem, which will continue to offer participants new and evolving opportunities in L2-compatible KLAYswap. As part of this evolving strategy, L2-compatible KLAYswap will lead and contribute to the mass adoption of Web3 in the new Silicon ecosystem beyond the KAIA ecosystem.

Thank you.