Leaky Thoughts by Core Contributor Sterling Archer
“He who controls the TOKE controls the flow of value.”
Background
The data-flows of Web2 are rapidly being replaced with value-flows in the form of tokens. This ongoing metamorphosis is the catalyst that propels the evolution of Web3. However, interacting with this liquidity is still far from frictionless. Web3 interactions correspond to value transfers; as such, it is necessary to minimize value losses, that is to say, it is necessary to maximize liquidity.
Tokemak is a decentralized market maker that maximizes the utility of tokens through their aggregation and transformation into liquidity. This is accomplished through Token Reactors and Pair Reactors where liquidity providers (LPs) can deposit tokens that will be deployed as liquidity to DEXs. Through this mechanism, all token holders can effortlessly earn yield and become LPs on Tokemak with single-sided exposure and without impermanent loss (IL) risks. This user abstraction for LPs enables the simplicity that is required to aggregate and convert Assets into tAssets (the token representation of assets deposited into Tokemak Reactors).
In addition to the improvement of Web3’s economic bandwidth via increased liquidity, Tokemak also allows projects to overcome the inflationary dependency that is intrinsic to the liquidity costs of Pool 2s (i.e. pool with a native token and its pair). Instead of attracting TVL in “liquidity loans” that cease when liquidity mining rewards decrease or disappear, protocols can acquire TOKE to direct liquidity to their pools with single-sided exposure and no IL risks. As projects seek to reduce liquidity costs and optimize capital efficiency, Pool 2s will be revamped into “Pool t1s” (pools containing the tAsset representation of a native token). This transition will drive the demand for TOKE for use in Token Reactors.
So what about the recently launched Pair Reactors that contain ETH and stablecoins? The “Curve Wars” have dominated the DeFi sphere in a battle for gauge weights that control CRV emissions on Curve pools. These emissions serve one purpose, peg stability. However, the long-term sustainability and growth of stablecoin projects can only be achieved with increased usage of their stablecoin, and this is where TOKE comes in.
The TOKE that is staked to each Pair Reactor controls the yield that is associated with that given pair. Due to this, stablecoin projects are incentivized to accumulate TOKE and stake it to the respective Pair Reactor to increase both integrations and organic demand. Through this process, the corresponding TVL of that Pair Asset increases thus maximizing its pairings and distribution within Tokemak’s network of liquidity.
The endgame for Tokemak is to become an omnipresent liquidity layer that spans across all DEXs and chains. By acting as a liquidity router that unifies Web3, Tokemak constitutes a new layer that exists “above” the DEXs and chains that are powered through its liquidity engine. As such, Pair Assets benefit from a global exposure to the entire liquidity layer.
This article explores the role of TOKE as a kingmaker for Pair Assets that seek to maximize organic adoption within Tokemak’s network of liquidity. Furthermore, it addresses the complementary nature that exists between the current “Curve Wars” and the upcoming “TOKE Wars”, where TOKE commands all flows of liquidity.
The Foundation of DeFi — Curve Finance
Stablecoins are a fundamental component of DeFi that provides the stability that is necessary for a functional financial ecosystem. Before Curve’s launch in 2020, decentralized stablecoins that remained pegged were a mirage within DeFi. Considering that at the time the available AMMs, such as Uniswap, only offered constant product bonding curves (which evenly distribute liquidity across all prices), this was to be expected.
Curve’s launch created a new era for DeFi. By introducing its Stableswap invariant that enables the concentration of liquidity around a specific price, it became possible to finally achieve reliable peg stability and greatly minimize slippage.
Deep liquidity on Curve became a synonym of tight peg stability for stablecoins. The minimized slippage that is possible due to Curve’s Stableswap invariant incentivizes arbitrage opportunities whenever the price slips off peg. This arbitrage process restores the stablecoin to its peg.
As a result, stablecoin protocols began to incentivize Curve pools with liquidity mining rewards (e.g. SPELL rewards to Curve’s MIM pool). However, this strategy inflates the supply of the governance token that is used to incentivize liquidity, and therefore, it creates additional sell pressure from yield farmers that sell their tokens.
Curve’s tokenomics constitute part of the solution to the liquidity costs that peg stability represents. By “vote-locking” CRV as veCRV into the platform (maximum voting power with 4 years lock), stakers can benefit from Curve’s trading fees (distributed as 3CRV), receive reward boosts up to 2.5x CRV, and more importantly, they have governance rights over Curve gauge weights. These gauges are the key that controls the CRV emissions that are attributed to Curve pools.
The rise of Convex created the separation between the revenue that is generated by veCRV and its governance. Each cvxCRV represents a claim over the revenue that is generated by the underlying veCRV that is locked by Convex, and each vlCVX represents the governance power that is associated with the same underlying. This governance derivative empowers CVX with the ability to be “vote-locked” as vlCVX for 16 weeks, consequently, it gives vlCVX holders access to the governance power of Convex’s underlying veCRV with a much smaller commitment period.
In order to decrease the liquidity costs that are inherent to peg stability, stablecoin projects started to bribe vlCVX holders through Votium in addition to the accumulation of CRV and CVX. This method is far more capital efficient than directly incentivizing Curve pools to increase their corresponding TVL.
In summary, the so-called “Curve Wars” represent an improvement in terms of capital efficiency where stablecoin projects seek to control Curve gauge weights as a stability mechanism. As a consequence, there is often a misalignment between the CRV emissions that these pools receive and the volume that they generate. This discrepancy is compensated with bribes for vlCVX holders, however, the concerns with the low market adoption of stablecoins that receive high emissions and generate low volume persist within the Curve community.
Beyond Peg Stability — “The TOKE Wars”
As aforementioned, the “Curve Wars” represent the next frontier in terms of capital efficiency for stablecoins that wish to control Curve gauge weights as a stability mechanism. This allows them to achieve a reliable peg and deep liquidity on Curve. Regardless, peg stability by itself isn’t enough for the long-term success of these projects.
- Bob deposits ABC tokens as collateral into a CDP (collateralized debt position);
- Bob mints 1000 units of stablecoin A;
- Given that stablecoin A isn’t widely integrated within DeFi, Bob swaps it for 1000 DAI;
- This swap creates a minor depeg of stablecoin A;
- Alice also has an open CDP and wants to pay her debt;
- Alice buys 1000 units of stablecoin A and burns it to close her CDP;
In this oversimplified example, it is evident that without integrations that foster organic demand there is a ceiling to the growth of stablecoin A. As a result, this stablecoin cannot expand its supply because it lacks the utility that is required for users to be willing to hold it.
This implies that to maintain its peg, the aforementioned protocol needs to incentivize with inflation a Curve pool where LPs are willing to hold stablecoin A in exchange for inflationary rewards. Due to this, it is possible to conclude that without organic demand for stablecoin A, its long-term sustainability is undermined.
There are multiple promising protocols with stablecoin distributions that are mostly concentrated in Curve pools. This reflects a lack of organic demand and a dependency on liquidity mining rewards to maintain peg stability. Additionally, LPs that provide liquidity to such pools create a strong sell pressure on the reward token that ultimately ends up diluting its holders. So how can stablecoins overcome the conundrum of lack of adoption?
There are multiple approaches that allow stablecoins to maximize integrations and improve organic demand:
- Partner with DEXs and aim to become the dominant trading pair within that market;
- Target DAOs and create proposals that facilitate treasury diversifications;
- Create opportunities that are only accessible with a specific stablecoin;
Despite the virtues of such approaches they are suboptimal when compared to the distribution that is attainable with Pair Reactors. Tokemak’s liquidity layer unifies and routes liquidity between DEXs and chains, for that reason, stablecoins that are present among its Pair Reactors are exposed to the distribution that is inherent to Tokemak’s liquidity layer.
Taking this into account, TOKE can be seen as a kingmaker that scales the distribution of stablecoins as trading pairs. The heuristic that is applied to Pair Reactors is simple: if one maximizes the amount of TOKE that is staked to a given Pair Asset, one maximizes its yield. That being the case, this Pair Asset will attract more TVL and thereby increase its pairings within the liquidity that is deployed by Tokemak.
For stablecoin projects, this implies that TOKE is an instrument that catalyzes integrations. By fostering organic demand and adding utility to stablecoins, the vicious cycle of pure farming purposes and mints that are immediately followed by swaps is broken. This creates a symbiotic relationship where “Curve Wars” mean stability, and “TOKE Wars” mean utility.
Example: The TOKE/FRAX Duality
Tokemak has several promising stablecoins integrated within its Pair Reactors (e.g. Fei, UST, LUSD, Frax, MIM), as well as prominent and widely adopted stablecoins such as USDC and DAI. To illustrate the synergies that can be created between TOKE and the adoption of such stablecoins, Frax will be used as an illustrative example.
Frax Finance has recently approved a proposal that aims to allocate up to 100M Frax to its Tokemak Pair Reactor, this represents a great value addition for both parties where Tokemak ensures that it has a large Frax reserve that can be deployed as pairings to its assets, and Frax benefits from the widespread distribution that can be achieved within Tokemak’s network of liquidity. However, this is only part of the symbiotic relationship that can be developed between both projects.
First, let’s dive into the mechanics of Frax Finance. Frax has adopted the veCRV token model, due to this, its FXS (Frax governance token) inflation is controlled through veFXS and it can be attributed to any pool that is paired with Frax. It’s important to emphasize that, unlike Curve gauges, Frax gauges can be present on any DEX and chain as long as there is a pool that is paired with Frax.
Considering that Tokemak’s liquidity layer will also expand to all DEXs and chains, this implies that every asset that is deployed with a Frax pairing becomes eligible to an FXS gauge. Saying that this is a powerful dynamic would be an understatement, as the overlap that is created by Frax’s widespread gauge distribution and Tokemak’s liquidity layer can create a symbiosis where Frax accumulates TOKE to increase its reserves and corresponding pairings within Tokemak, and Tokemak can continuously accumulate and lock FXS as veFXS to vote on its own Frax gauge weights.
Taking into account that Convex has now integrated Frax Finance, FXS will be continuously locked as veFXS into Convex with a liquid cvxFXS secondary market where users can exit their staked FXS positions. Due to this integration, it will be possible for Tokemak to incentivize vlCVX holders to vote on its own Frax pairings and maximize the gauge weights that are associated with them. By doing so, Tokemak can continuously accrue FXS rewards that can be locked as veFXS thus increasing its voting power over Frax gauge weights. Furthermore, Tokemak would simultaneously benefit from the revenue that is distributed from Frax Finance to veFXS stakers.
In summary, as Frax Finance accumulates TOKE, it increases its Frax reserves on Tokemak Pair Reactors, therefore, the protocol can improve its distribution and increase the existing organic demand for Frax. For Tokemak, this implies that as Frax pairings increase, the number of pools that are available for gauge weights are equally maximized. Through the accumulation of FXS rewards, Tokemak can vote on its own gauge weights thereby maximizing its revenue independently of the volume that is generated by such pairs.
Keep in mind that this is one illustrative example, and similar synergies exist with the other stablecoins that Tokemak supports.
TOKE, the Meta-Governor
Without getting into the undisclosed developments that Liquidity Wizard has prepared for the Tokemak community, it is safe to announce that Tokemak will start to strategically accumulate both CVX and CRV.
Additionally, if everything goes according to plan, Tokemechs will finally be able to circumvent the restrictions that are imposed through Tokemak cycles and it will become possible to swap tAssets and Assets leveraging deep composability with Curve for same-peg assets.
Besides the benefits that will be disclosed with the liquidity-debt duality, this represents a major utility improvement for Tokemak users, and it will also drive volume to Curve pools that can be generalized to any tAsset/Asset pair that is present in Tokemak reactors.
As a result, TOKE will become backed by CVX and CRV. This empowers TOKE with meta-governance powers that will allow stablecoins to maximize organic adoption, while simultaneously improving peg stability by leveraging TOKE’s underlying governance power.
Conclusion
Token and Pair Reactors are the duality that powers Tokemak’s liquidity engine. This black hole of liquidity absorbs tokens (regardless of their idiosyncrasies) and matches them with Pair Assets that can be deployed as liquidity to any venue on any chain.
From the perspective of Token Reactors, this means that the costs and friction that are associated with Pool 2s can be abstracted through the capital efficiency of single-sided exposure and the absence of IL risks. This implies that projects can reduce liquidity-related costs, and all token holders can become LPs without the aforementioned friction. As a result, Assets will become tAssets, and Pools 2s will become Pool t1s. By aligning interests among all shareholders, Tokemak maximizes Web3’s available liquidity and minimizes value losses while interacting with it.
From the perspective of Pair Reactors, this means that promising stablecoins that have so far struggled to increase distribution, are now empowered with TOKE as an instrument that allows them to catalyze integrations within Tokemak’s network of liquidity and foster the organic demand that is required for their long-term success.
Introducing this novel form of utility as the next chapter of the “Curve Wars” is an understatement. Curve is the building block of DeFi that enables peg stability, Convex unleashes the power of the veToken model by separating revenue and governance power, and Tokemak constitutes a new superset that empowers all tokens with a widespread distribution that is commanded by TOKE, and is only limited by the expansion of Web3.
As the passage of time margin calls projects that overspend their budgets on liquidity, the demand for TOKE will grow. The rise of CVX due to its improved capital efficiency when compared to the direct incentivization of Curve pools is an omen of TOKE’s future success at a Pool 2 level. But this won’t be the only catalyst for such demand. Stablecoin projects will also rely on TOKE as an instrument that catalyzes adoption, and DAOs will accumulate TOKE to control the flows of liquidity within the “internet of value”. Once again, the growth of Tokemak is only limited by the growth of Web3.
It is also worth noting that as Tokemak externalizes inflation, it internalizes value through trading fees and LP rewards that grow its Protocol-Controlled Assets (PCA). Once the singularity is reached, Tokemak becomes independent of third-party LPs and TOKE emissions come to a halt. This point marks the transition from inflationary-based liquidity, to a sustainable model that relies on organic economic activity. Additionally, this discontinuation of TOKE emissions implies that demand will become further exacerbated while the underlying PCA maintains its expansion.
In summary, for governance tokens Tokemak represents capital efficiency and control over liquidity, for stablecoins Tokemak represents widespread distribution, and for Web3 Tokemak represents sustainable liquidity. In the novel internet where liquidity is ubiquitous, TOKE is the Kingmaker.
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