Go2Mars Research
Liquidity is the cornerstone of finance. Whether it is the stock market, real estate or Defi, liquidity is one of the key indicators to test the quality of its market. In the Defi market, the game between liquidity and fairness is going on from beginning to end. How to balance the relationship between the two is a similar problem we experienced in the 1980s.
It’s just that today is different from the past. In Defi, the financial instruments we can use are more diverse and the game mechanics are more flexible.
Therefore, this article will take the traditional decentralized exchange (DEX) as the starting point and the Chronos exchange as the research target, and break down in detail how Chronos uses the ve(3,3) model to participate in this efficiency and fairness game. among.
Traditional DEX: the first attempt at liquidity optimization
How to deal with the liquidity and fairness of the Defi market, the first batch of decentralized exchanges have made some fruitful attempts to explore in the early years, taking Uniswap, the leading DEX exchange in the current Defi market, as an example.
In the Uniswap V2 pool, liquidity is uniformly distributed along the invariant curve of xy=k. However, most trading activity occurs within a specific range at any given time, resulting in underutilized liquidity in other parts of the xy=k curve.
In order to maximize the value of market liquidity space, Uniswap V3 concentrates liquidity within a more active range in specific trading volumes. Although this mechanism can improve capital efficiency and allow liquidity providers (LPs) to obtain higher liquidity returns.
However, the relationship between efficiency and fairness cannot be solved so easily. Higher liquidity represents a greater loss of token utility.
Uniswap V3’s centralized liquidity model requires LPs to actively manage their positions as they must adjust price ranges to optimize returns. Due to the large fluctuations in the price of new coins, LP needs to frequently adjust the price range. This will generate huge capital risks, which will not only increase the liquidity cost of blockchain management, but also mean that LPs need to passively give up their own pricing rights——
System failure under extreme market conditions: The centralized liquidity model may not work optimally during periods of high market volatility; for example, Uniswap V3 did not function properly during the Luna crisis compared to the V2 version.
High entry threshold: For project parties issuing initial tokens, V3’s liquidity management threshold is too high for the long-tail asset pool launched by new projects.
Amplification of Potential Risk of Loss: Concentrated liquidity acts as “leverage” by concentrating funds within a specific trading range. This means that potential profits and liquidity within the range are amplified, but so are potential losses when the asset trades outside the range.
Ve(3,3) model: a financial flywheel with insight into human nature
Liquidity growth flywheel based on four major trading entities
Compared with the above-mentioned veCRV model, the ve(3,3) model has a deeper understanding of fairness and efficiency. In order to facilitate readers' understanding, let's first sort out the four participating entities in the DEX economy:
Trader: can be compared to an investment trader in the stock market. Traders perform swaps from token A to token B from the liquidity pool, and at the same time need to pay corresponding transaction fees (handling fees) during the swap process.
Liquidity Provider (LP): It can be compared to corporate shareholders in the stock market. LPs will receive token emissions by placing their idle tokens into the liquidity pool. In exchange for TOKEN emissions, all transaction fees earned through trading are sent to veTOKEN voters who voted for that specific liquidity pool.
Protocol: Projects require liquidity so users can purchase their tokens. To incentivize liquidity providers, projects can bribe the meter to incentivize veTOKEN voters to vote for their LP pairs. (Income #2). Protocols are also highly incentivized to acquire their own veTOKEN to bootstrap emissions as a long-term solution to their liquidity needs so that they don't have to maintain bribery metrics forever.
veTOKEN voters: can be compared to regulators in the stock market. Voters manage TOKEN emissions through weekly votes on the meter. They are incentivized to vote for the most economical mining pool to maximize their revenue, as they receive fees + bribes from the mining pools they vote for.
The flywheel of the Ve(3,3) model can be roughly divided into three steps:
The first step: LP invests idle tokens to increase market liquidity. LP puts idle tokens (funds) into the liquidity pool, thus bringing lubrication to the entire market. Market trading volume increases, and the workload of the protocols that provide services for market exchanges also increases, and an active market also means that Higher currency prices.
Step 2: The increase in transaction volume will increase the income of veToken voters. The surge in the number of transactions caused by increased liquidity means a simultaneous increase in transaction fees within the limited transaction "computing power", so veToken voters will receive more commissions from transaction fees.
Step 3: High-quality markets attract more external investors, and the market completes a positive cycle. Under a good market environment, more external investors are attracted and choose to replace their idle tokens with locked tokens, and the market currency price is further supported. On the other hand, since the income of LP is strongly related to the currency price, the higher the currency price, the higher the income of LP, so LP will have more idle tokens put into the liquidity pool, and the second cycle begins.
Second strengthening of liquidity and fairness: “bribery” and “inflation”
In the ve(3,3) model, there are two important rule mechanisms that promote market liquidity and fairness: "bribery" and inflation.
In order to promote market liquidity, based on the original flywheel, the ve(3,3) model also adds an interesting "bribery" mechanism - LP can use part of its income to "bribe" veToken voters in order to This will guide voters to regard their own mining pool as the most economical one, thereby attracting more external investors. This apparent "bribery" further promotes the improvement of overall market liquidity.
In addition to liquidity, the ve(3,3) model also introduces an inflation mechanism - the more tokens invested in the early stage, the more benefits will be gained after inflation. Inflation is a gradual process of governance redistribution that, over time, favors those who are more loyal to the community and the market.
In our case using the Solidly model, loyalty is represented by the continued accumulation of TOKEN and the locking of veTOKEN. This allows projects to maintain on-chain liquidity and keep the flywheel spinning at an efficient cost.
In addition, the advantages of the inflation mechanism are:
1. Decentralize voting power and allow new participants (projects) to enter the economy and receive their fair share of votes through bribery or veTOKEN accrual.
2. Create total demand for TOKEN by incentivizing projects to continuously accumulate more veTOKEN to maintain their share of emissions.
3. Ensure that veTOKEN voters strictly use their funds (votes) on the most productive mining pools. Failure to do so will mean they are losers.
4. Maintain the ve(3,3) flywheel by providing adequate compensation to liquidity providers.
Secondary distribution after inflation: 100% Rebase Ratio mechanism
Although the inflation mechanism enhances the personal benefits of veToken voters, it also dilutes their voting rights. The existence of the 100% Rebase Ratio mechanism is another innovative attempt to suppress such dilution.
Rebase ratio: that is, the extent to which ve token locker rights are diluted by reducing inflation. Mathematically, it can be calculated as the ratio of the proportion of total vetokens after incentive emission in each cycle to the proportion of total vetokens before emission. Inflation reaches the upper limit of 100%. Existing locker rights cannot be diluted at all.
The model aims to maintain the ownership status of veTOKEN holders by allocating additional veTOKEN to them in each epoch in proportion to the number of tokens launched.
At the same time, ve(3,3) also sets the relevant dilution upper limit. Cap anti-dilution is designed to balance early adoption incentives with long-term project health. This model provides 100% anti-dilution until a lock-in rate of 30% is reached, after which the rebase ratio decreases as the lock-in rate increases.
While it sounds attractive in theory, the 100% rebase ratio model comes with some negative side effects.
1. Concentration of voting power: Over time, this model leads to an unhealthy concentration of voting power among early users as they continue to accumulate tokens without dilution.
2. Inhibition of new participants: The concentration of voting rights makes it increasingly difficult for new participants to enter the ecosystem, thereby reducing competitiveness and market access.
3. Inflationary pressure: By redistributing inflation from liquidity providers to veTOKEN holders, this model introduces unnecessary inflation, thereby reducing the value of purchasing and locking tokens.
The more veTOKEN you have, the less revenue you receive per veTOKEN, so the value of purchasing new TOKEN issuance for locking and voting decreases. This is a critical part of the flywheel and it can be damaged by excessive repositioning.
Improvements to Chronos: 0 Rebase Ratio vs. maNFT
0 Rebase Ratio
The Chronos team determined that a zero-rebasing model was the best approach for the long-lasting stability and sustainability of the project. This model not only ensures the most favorable economic incentives for all participants, but also attracts new protocols and mitigates supply concentration among early adopters.
But at the same time, the protocol also realizes that there are certain risks in locking up veCHR tokens early, so in order to reward early adopters without compromising the long-term sustainability of the project, Chronos has reserved 5% of the initial supply of $CHR (2.5 million tokens ) as an airdrop reward for users who have locked up more than 1,500 $CHR for two years. These users will be rewarded with 20% of their locked position in $veCHR NFTs.
ma(Maturity-Adjusted)NFT
While ve(3,3) has gone a long way in attracting token liquidity, they are less effective at maintaining liquidity over the long term, and LPs looking for the best return on investment are still driven by high APRs.
As the APR changes from one epoch to the next, liquidity providers simply move their funds into the pool that generates the highest returns. Liquidity is not “sticky” – it doesn’t stay in one place for long – and these fluctuations make it difficult for protocols to predict exactly what their liquidity needs will be – and what incentives they need to provide – to help them reach their The goal.
Liquidity provision on Chronos works the same as on other ve(3,3) DEXs. Users deposit liquidity to receive LP tokens and stake these tokens to earn $CHR rewards. After staking their LP in Reliquary, users will receive a special NFT (called a maNFT) that tracks when and how many tokens the LP staked, as well as how much time has elapsed since the LP provided liquidity.
As the LP mortgage time increases, the incentive multiple for LP increases in each cycle.
Chronos has chosen a linear curve to ensure that new LP depositors will still receive their fair share of rewards that will grow in tandem with their time on Chronos. It also maxes out at 6 weeks to ensure that very early and long-held LP positions don't unbalance the pool with large fees while new entrants get nothing.
In a market where a maNFT position can be sold in a mature state, the value of this liquidity position will exceed the sum of its underlying contents. By increasing the incentive multiplier over time, the Chronos protocol introduces liquidity into time value, thus regulating liquidity in the long-term time dimension.
The ultimate form of innovation: the Chronos flywheel
When CHR prices fall, there is a countercyclical effect that supports this flywheel, causing veCHR APR to increase. A lower price with the same revenue results in a higher APR, making CHR a more attractive investment. Ultimately, buyers will seize this pricing opportunity, stabilizing CHR prices and keeping the flywheel spinning.
Previous ve(3,3) projects have faced difficulties maintaining their flywheel during market fluctuations. When DEX token prices drop, liquidity tends to be drained away as the APR decreases. When DEX tokens fall and TVL flees, it is very difficult to stabilize the price of DEX tokens and restart the flywheel.
Chronos introduces the concept of maturity-adjusted limited partners, which can manage liquidity in the time dimension and reduce liquidity flight.
Summary
By adopting a maturity-adjusted LP model, Chronos enables liquidity providers to benefit by introducing a time value component into their LP positions. At the same time, this model supports the protocol by creating a stickier and more stable total value locked (TVL), thereby better supporting the issuance of $CHR.
For its part, the protocol will benefit from continued, predictable liquidity. Capital will be less likely to be moved from one pool to another each period in pursuit of the highest annualized rate of return (APR). Liquidity providers now need to weigh their options more carefully between short-term incentives and long-term profit potential. In addition, projects can also increase the liquidity owned by the protocol by purchasing mature LP positions - maNFT directly from the secondary market.
For liquidity providers, they will benefit from increasing earnings multiples over time and the possibility of selling mature liquidity positions at a premium in the secondary market.
For $veCHR holders, their benefits from vote buying will increase. Due to the high opportunity cost of LP liquidity in the short term, project parties hoping to obtain initial liquidity need to invest more money in vote bribery. This will further encourage project parties to direct more incentives to their own liquidity pools to attract LPs. Additionally, since TVL is less volatile, they can look forward to a more stable stream of transaction fee revenue.
In the Chronos protocol, the position of the liquidity provider (LP) - maNFT is regarded as a special financial instrument with underlying income and gradually increasing value over time. We have reason to believe that the secondary level formed on this basis Spin-offs will be coming soon. These derivative protocols may contain various innovative features to provide market participants with more diverse and rich investment and trading options.
In the future, secondary derivative agreements may appear in various forms, such as options, futures, swap contracts, etc. These financial instruments have the potential to further combine and divide LP positions to meet the needs of investors in risk management, arbitrage, portfolio diversification, etc. At the same time, these emerging financial products may also attract more funds to flow into the market, thereby increasing market liquidity and trading activity.
As market researchers and observers, we will pay close attention to developments in the DEFI field, aiming to keep abreast of market changes and emerging trends. In this rapidly developing market, we will be committed to in-depth research on the operating mechanisms and risk characteristics of various innovative products to help readers better understand these phenomena.
references:
[1] Case Study: Why ve(3,3) Needs Sticky Liquidity
[2] The Pillars of Chronos Pt. 3— Understanding the Chronos Flywheel
[3] The Pillars of Chronos Pt. 2— Introducing Maturity-Adjusted LPs
[4] Solidly Deep Dive Pt.1: Economics, Inflation, Rebasing, Sustainability
[5] Solidly Deep Dive Pt.2: Concentrated Liquidity and ve(3,3) vs. Uniswap
