The Near-Perfect DeFi Primitive
Introducing the all-new utility-strengthened floor DeFi primitive
DeFi Ponzis are only 1.5 years old and have already evolved thrice. With each evolution we have enjoyed a quantum leap from its ancestor, inventing a new primitive along the way, in addition to the creation of new cultures and mindsets. Every step of the way, DeFi users’ brains got rewired to understand that what wasn’t thought possible, suddenly was. Allow me take you on a stroll through how we got to where we are, and where our next leap will land us.
DeFi 1.0 — previously known as: DeFi
SushiSwap and its $SUSHI token are representative of this category, as they really nailed their tokenomics and created an original incentive system to aid in siphoning liquidity from Uniswap. Let’s delve into how SUSHI works to define the mechanics behind DeFi 1.0. SushiSwap is a Uniswap fork (a DEX) that allows trading between token pairs.
The DeFi 1.0 model is all about creating a token, filling the platform Treasury with it, then bootstrapping liquidity into the platform by increasing the value of the token via Ponzinomics, thus increasing the value of the Treasury.
How does SushiSwap do this?
They charge a 0.3% fee on all trades, of which 0.25% are kept in the liquidity pools as income to liquidity providers, and the other 0.05% is used by the platform to buy $SUSHI off the market.
What do they do with the purchased SUSHI?
Send it to SUSHI stakers.
What is the intended effect of this dynamic?
As mentioned, SushiSwap Treasury’s principal asset (by far) is SUSHI. Their most direct path to growth is thus an increase in price of their token. This is achieved by incentivizing SUSHI holders to stake their tokens for attractive APYs. So, by using 0.05% of all trading fees to buy SUSHI off the market, thus pumping the price, and paying it back to SUSHI stakers they meet both objectives.
What is the elephant in the room?
Seems like the perfect Ponzi right? But SUSHI price collapsed. So, what is the problem with this model?
If you ask 10 people, you’ll get 11 opinions with what the problem is. If you ask me, there are three reasons:
- There isn’t a direct link between SUSHI’s value and the platform’s cash-flows (trading fee revenue). In other words, SUSHI price could be worth 10x more or 1/10 the current price, and the platform’s trading fee to SUSHI-buy-pressure mechanics wouldn’t be much different, as staking rewards are paid in the token itself.
- The platform’s principal income is predicated on the appreciation of the Treasury’s underlying asset: SUSHI. In other words, the platform doesn’t accumulate many non-SUSHI revenues. And in order to diversify the Treasury, SUSHI must be sold (dumped) into other assets.
- Lastly, the most commonly stated problem with DeFi 1.0 tokens. DEXs depend on users to provide liquidity to the protocols, as price slippage is reduced the more liquidity is available. Less price slippage for a given token pair will bring in more traders. But as liquidity migrates to other platforms, users migrate along with it. So DEXs are forced to provide higher and higher incentives to LPs to keep them along for the ride. These incentives are paid with their main Treasury asset (e.g. SUSHI), thus constantly diluting it.
DeFi 2.0 Comes Along to Save the Day
As DeFi tokens were losing steam, in October 2021, about 7 months after its launch, Olympus’ OHM came onto the main stage. Olympus, a platform designed by giga-brained anon Zeus, had the world excited about a different approach to DeFi. The concept connected so well with degens, that in the following months, endless forks of the Olympus DAO codebase were being deployed across Ethereum and any other L1 you could think of.
Olympus DAO’s mission was to create a crypto-backed stablecoin to address the cryptocurrency market’s over-reliance on fiat-backed stablecoins.
The way Olympus did this was by creating a governance token called OHM which was minted every time OHM supply outpaced the reserve’s crypto-assets, and burned when the price of 1 OHM went below $1. Olympus built a self-defense mechanism into OHM tokenomics to prevent LPs from migrating their liquidity to the new flavor of the day DeFi project. How did they do it? They owned over 99% of their own liquidity. In other words, the platform was the LP.
How did the platform continually accrue value with which to buy its liquidity?
That’s where Olympus’ second big innovation came in: bonding and rebasing. Olympus DAO would sell bonds of timelocked OHM, which users paid for with (among other assets) the platform’s LP tokens, allowing Olympus to hoard its own liquidity. In addition, Olympus incentivized users to immobilize their OHM (keeping it off the market) by staking it to receive more OHM at unbelievable APYs. They called this rebasing.
To summarize —
- The platform owns virtually all of its liquidity, so it doesn’t depend on LPs
- The platform continuously accumulates assets via the bonding mechanism, allowing the protocol for more OHM to be printed, which enables it to continuously deliver tremendous APYs to stakers.
- Since stakers are highly incentivized to continue staking, very little OHM hits the market, and price further rises. This collaborative staking is deemed a game-theoretic (3, 3).
And the cycle continues. Forever.
No. At some point the community grows large enough that the loyalty of newcomers to the (3,3) philosophy is debilitated, and some start unstaking and selling. In addition, Olympus DAO’s Treasury is mostly denominated in its own token, and more importantly, it’s own LP tokens. This means that as OHM’s price falls, impermanent loss kicks in with a negative quadratic effect on price. Before you know it, OHM loses 99% of its value, and the Ponzionic promise of never-ending returns is broken.
It was time for a new paradigm. Enter what I call DeFi 3.0.
DeFi 3.0 — ETH Cash Flows
ETH is king, and it was long overdue that DeFi platforms put ETH in its due place. Imagine a platform that provides users with utility and offered them and others the right to own perpetual ETH revenues derived from its utility.
In January, LooksRare (LR) launched with the mission of dethroning OpenSea, the biggest NFT marketplace in the world. Their plan was to airdrop their $LOOKS token to OpenSea users and sell them on the fact that all of LooksRare’s revenue is streamed to LOOKS stakers. Why use OpenSea to trade if you could trade on a platform that you own?
But LooksRare had a problem: their marketplace needed liquidity to compete with OpenSea. That is, they needed people to list their NFTs and people to come buy them. The way they are solving this is mesmerizing:
- Aside from streaming ETH to its LOOKS stakers every single block, they also stream LOOKS.
- Users are incentivized to trade on LR, as they get a share of daily trading rewards paid in LOOKS. Here’s where it gets interesting. If the dollar value of LOOKS paid out as trading rewards exceeds the amount spent in trading fees (in ETH), you can make money as a trader by selling the LOOKS for profit. This brought a wave of traders that would sell overpriced NFTs to themselves in order to receive trading rewards.
- A mere day after launch, this elevated trading volume caused LooksRare ETH revenue to surpass OpenSea’s, benefitting LOOKS stakers who were rewarded with relatively large ETH streams (thus high APYs), with the clear winner being the LooksRare treasury, that controlled a significant stake of existing LOOKS. This is how LooksRare bootstrapped their ETH liquidity.
- A few weeks passed, and LR had accumulated so much ETH that they stopped LP rewards and took control as the platform’s super-majority LP.
- LooksRare continues adding to its platform, incentivizing listing more NFTs, and is betting on organic trading volume taking over before its Ponzinomics are halted when the LOOKS rewards period finishes at the end of year 2.
Now, this must be the perfect DeFi Ponzi.
What if there was something better?
DeFi 4.0 — The Utility-strengthened-floor with upside
Enter NFTR. Disclaimer: I am the founder.
NFTR (Nifter) is the first NFT naming registry on Ethereum, and aims to be the go-to place to name and reference NFT names, as ENS did with Ethereum addresses. Each name is 1/1 unique and transactable, adding a value-layer to NFTs.
RNM is Nifter’s staking and governance token. Nifter’s tokenomics are similar to LooksRare’s in the sense that stakers are streamed all of the platform’s ETH revenues, RNM tokens will be airdropped to LooksRare users, namers receive naming incentives in the form of RNM tokens, and other user-types such as bluechip NFT owners farm RNM just for naming and holding their NFTs. In NFTR’s case incentives aren’t in place to steal liquidity from another platform, as we are creating a new market — the market for NFT names. Our incentives are designed to create awareness and bootstrap liquidity for growth as the concept of naming NFTs spreads.
So, where does the magic come in?
NFT naming can be paid for with 0.05 ETH or 1,000 RNM. RNM fees burn. If 1,000 RNM < 0.05 ETH, RNM gains buy pressure and deflationary pressure until the floor is regained. Therefore, RNM has a built-in floor value of 0.00005 ETH/RNM with unrestricted upside. If 1,000 RNM > 0.05 ETH, the platform accrues ETH revenue which is all streamed to its stakers.
RNM price upside (above 0.00005 ETH/RNM) arises from parties that are interested in staking to receive more RNM and more importantly, precious ETH revenue share.
What problem did we solve?
LooksRare’s model is a near perfect ETH-based liquidity bootstrapping Ponzi, that isn’t really a Ponzi, as the more LOOKS you accumulate, the higher your share of perpetual platform ETH revenue. So as long as the platform continues to be useful and have volume, you are accumulating a token that entitles you to streams of ETH, the most precious token on Ethereum, arguably in all of crypto.
Then, what is the problem? LOOKS doesn’t have a built-in mechanism that allows it to sustain a minimum value. In other words, its value is at the whim of traders.
RNM on the other hand, has the same functional upside as LOOKS, but has an algorithmically strengthened floor which is backed by the platform’s utility.
And that, my friends, is DeFi 4.0.