Introducing Lithium Finance’s Determinant-based Mutual Information (DMI) Mechanism
Lithium is the first collective-intelligence pricing oracle to give precise and timely pricing on private, illiquid assets. Our goal is to create a bridge between DeFi and traditional financial services and functions that opens doors for millions of assets for investors across the globe. We want to have top investors and institutional advisors as clients, as well as the kinds of retail investors who made waves on social media. Lithium is a community of coexistence.
However, this vision cannot be realized without the right pricing oracle, and the market still has not seen one able to price illiquid real-world assets effectively. Lithium is the missing link between capital markets and DeFi. Our oracle is built on a Determinant-based Mutual Information (DMI) mechanism, in which voluntary participants are asked subjective multiple-choice questions to find a dominant truth requested by a wisdom seeker. The final generated answer then provides price discovery for illiquid assets.
Over the past few weeks, our team has received many questions about this DMI, how it works, and why we are confident in its performance. Below, we will answer some of these important questions by running through an actual scenario our team tested — actually asking a pricing question and receiving an answer using the DMI.
On April 14, 2021 — in what was described as a watershed moment for our industry, the largest crypto platform in the U.S. geared up its public debut on the Nasdaq. After much speculation, Coinbase began trading at $381 per share, a 52% increase over a $250 reference price set by Nasdaq on Tuesday. The stock swung as low as $310 and as high as $429 — showing once again how valuable a reference point is in the early days of public stock. Luckily, in the weeks prior to the IPO, we had Lithium — and we predicted the IPO price.
Let’s walk through all the steps in the price determination process:
- Pricing Questions Asked
- Answer Collection
- Answers Processing (Implementation)
- Answers Release
- Rewards Available For Pick-up
1. Pricing Questions Asked
A Wisdom Seeker wants to know what Coinbase might price on IPO. They pose this question to Lithium Finance and post a bounty in $LITH tokens (staking) in advance of the IPO. The question on “What will Coinbase IPO price be on its first day of trading?” was combined with a series of other pricing questions — some for traditional cryptocurrencies, like bitcoin, others for traditional wall street stock predictions, like the S&P 500.
2. Answers Collection
Wisdom Nodes are experts who have knowledge in the latest pricing of private companies — they could be brokers, analysts, investors, or anyone familiar with private market activities. Wisdom Nodes receive a set of questions from above and answer the multiple choice questions and stake their answer, which signals a confidence rating in their results. The Lithium protocol throws away answers that are not complete. The protocol sorts the answers provided by these Wisdom Nodes based on relative answers to ground truth questions. Reputation is an added incentive to encourage correctness amongst Wisdom Nodes over time. Initially, individuals may have low or no reputation, but they receive a higher reward as their performance improves. The closer a Wisdom Node is to the final ground truth, the higher their compensation. In addition, the more an individual signals their confidence in the results (by staking more tokens), the more they earn, enabling a solid feedback loop to encourage positive, honest behavior and further strengthening the protocol.
3. Answers Processing (Implementation)
Once either the ground truth is known or the time limit is up, the answering process stops, and the answers are aggregated, and the solution is calculated using the DMI-Mechanism. The answers are placed into two matrices, and they are randomly shuffled within the matrix and between those matrices.
Figure 1: Wisdom Nodes’ answer aggregation matrix
Source: Lithium Finance
By arranging the answers into a matrix and calculating the product of the determinant in those matrices, the honest consensus will reinforce each other across the determinant and create a vector of answers and corresponding payments. The matrix allows for strongly-correlated answers to group together and random answers to be diluted and not contribute to the response. A vector of payments provides the proper reward for each node.
Matrix calculation details
Referring to Figure 1, answers in the agreement will provide strong values in A11, A22, A33 and will receive the largest percentage of rewards and improvements to their overall reputation. Malicious answers will be placed far from the central axis and mainly in the A31 and A13, which will result in their stake and reputation being slashed. Those in-between will receive a smaller percentage of the overall reward pool and no change to their reputation (A32 or A12, for example). The Lithium protocol statistically weighs the percentage of some of the answers and then calculates the actual price value.
4. Answers Release
Once all of the data is aggregated, the final price of the illiquid asset in question is published. The time value of data is where the value of the information provided lies. The later the data is provided, the less valuable it gets to the Wisdom Seeker(s), and the data can even become a liability after a point, therefore the pricing information is released to those who stake the highest bounty first, then gradually to each new bounty level. After a certain period of time, it moves into the public domain. (Generally speaking, pricing information has very little proprietary value after a week, and often less time). Then rewards are available to be claimed by the Wisdom Nodes, and their reputations are updated. Moreover, to ensure post-event audit confirmation of correctness, the data’s sequence and the path will be disclosed. However, for every epoch (an epoch starts when a question is posed to final disclosure of pricing information), the specific identity will be hashed to prevent a malicious actor from aggregating reputation information. To ensure the mechanism’s effective functioning, a Wisdom Seeker can only see the aggregated performance of a Wisdom node and does not have access to disaggregated data.
5. Rewards Available For Pick-up
Once the ground truth is revealed (pricing of IPO, for example), the rewards are paid out to those who were closest, and the reputations of the Wisdom Nodes (experts/oracles) are updated. The rewards are available for pick up through the DApp, and members can redeem the Lithium tokens deposited into it. Rewards are granted to those who made an honest answer to the questions. The majority of the people who gave answers will receive small rewards, and a small percentage will lose reputation and lose their stake. Only malpractitioners who actively give bad information get docked on their reputation and stake and get expunged from the network.
Members can hold Lithium tokens and become part owners in the protocol, and get a high reputation by doing so. Members can realistically make much profit on the platform as the reputation multiplied by staking value is the value one can take away from the platform. Lithium is a deflationary currency, so early players stand to gain a lot from holding the $LITH token.
How Lithium Deals With Dishonest Players
The DMI mechanism is aware that people will try to manipulate a result and accounts for attack vectors. Not every answer provided by a Wisdom Node gets counted towards the price that the Lithium protocol comes up with. The protocol has three robust layers of defense against bad players and malpractices designed to mess with the protocol. Once the consensus answer or ground truth is uncovered, not only will the malicious actor’s reputation be slashed, so will all of their stake. In an attempt to collude with several malicious actors, the amount of funds required to stake plus the lack of direct influence (due to the random down-selection) means all of these funds will get slashed, and the resulting answers will not be impacted. We will soon be adding even more layers of protection against malpractice in the ecosystem.
The hype around the cryptocurrency world’s first IPO led some to speculate a market cap as large as $200 billion. While the consensus around the industry was a bullish one for the Coinbase IPO, Lithium’s price discovery told a rational story for Coinbase, pricing it around $90 billion. As shocking as the figure may have seemed at that time, crypto demons were felt around the globe, and sure enough, Coinbase opened at a market cap of $99 billion.
Where Do We Go From Here?
As we are beginning to see, with Lithium Finance and its powerful DMI mechanism, Wisdom Seekers will be able to source prices for any asset through a decentralized honest-rewarding protocol, all on-chain. IPO prices are just the beginning — Lithium can also price real estate, art, antiques, private stocks, and much more. Millions of people can benefit from effective price discovery for illiquid assets. The Lithium team is excited to bring this project to market.
Read more about Lithium on our website: https://lith.finance