This article will give UX Designers an understanding of emerging concepts in DeFi 2.0, like protocol controlled value and liquidity as a service. OlympusDAO is a great example of both of these. This is part of an overall Web3 Design Bootcamp that teaches UX Designers about Web3 concepts and design patterns so they can land a job in the rapidly merging field.
We know that liquidity is important in all aspects of DeFi. Without tokens in liquidity pools you can’t make swaps on DEXs, borrow tokens in lending protocols, and enact automated yield farming strategies. Without liquidity DeFi grinds to a halt. And the more liquidity the better. For example, the more liquidity in a DEXs liquidity pool, the less slippage users are subjected to when making token swaps. That’s why DeFi protocols compete with one another to attract liquidity, and increase the TVL of their protocol.
Liquidity mining, first seen with Compound in 2020, attempted to overcome the liquidity bootstrapping challenge. Protocols mint their governance token, and distribute it incrementally as a reward to its liquidity providers. Unfortunately, this only solves the liquidity problem in the short-term. Liquidity mining programs attract mercenary capital. Without loyalty to any single protocol, users switch their liquidity between protocols whenever higher interest rates popup elsewhere. It’s difficult for protocols to maintain this liquidity, and they have to continue inflating their governance token in order to do so. But more and more, liquidity is managed at the protocol-level, called “protocol controlled liquidity” or “protocol owned liquidity”.
DeFi 1.0 protocols do not own user liquidity. Users own their LP tokens, and can redeem them for the underlying liquidity at any time. This is changing in DeFi 2.0. Let’s go back to OlympusDAO, and users bonding their crypto in the treasury. Here, user crypto is exchange for discounted OHM. In this case, the users no longer own their liquidity – the liquidity is now permanently held in OlympusDAO treasury. In fact, OlympusDAO controls over 99% of its liquidity in DEXs (e.g. OHM-FRAX LP & OHM-DAI LP).
This ensures that the liquidity remains in place so that users can trade in and out of OHM, with low slippage. Also, the protocol earns almost all of the liquidity pool trading fees, and is becoming a large holder of SUSHI, which all work to further grow the protocol.
Frax Protocol is another good example of PCV. Users mint FRAX stablecoin by depositing their crypto assets into Frax protocol’s reserves. Frax Protocol applies automated market operations (AOMs) on its reserves for a variety of reasons. For example, its collateral investor AMO moves USDC reserves into lending protocols like Compound and Yearn, which earns interest. Another AMO provides FRAX liquidity on exchanges like Curve and Uniswap to ensure deep liquidity pools for FRAX-stablecoin pairs. Fei Protocol is similar – the protocol controls reserves for yield farming strategies to grow its reserves, as well as to provide FEI liquidity on Uniswap.
These protocols can also rent out their liquidity to other DeFi protocols, known as liquidity-as-a-service (LaaS). Tokemak is a great example of this. Essentially, individual liquidity providers deposit tokens into reactors, and liquidity directors (LDs) rent out this liquidity to various DEXs. LD’s create liquidity on-demand – they vote on which token reactors get paired together, and which DEXs to send these token pairs to. Of course, Tokemak earns DEX trading fees, which its building up a treasury with. This treasury, controlled by TOKE governance, will be utilized for additional LaaS operations in the future. Tokemak is like a liquidity aggregator, supplying liquidity to other specific areas in the DeFi ecosystem.
Finally, LaaS is being used to help other up-and-coming protocols launch their native token. Before, to start sellings a token on a DEX you either needed to seed the liquidity pool with a lot of up front capital, or attract users to bring their own liquidity. This brings us back to liquidity mining, which we’ve already established is ineffective in the long run. However, now, OlympusDAO launched a product called Olympus Pro, which generalizes its token bonding mechanism for other protocols. For example, users can bond their LP tokens in exchange for the protocol’s discounted governance token. Now that protocol owns the LP tokens, so the liquidity will remain in place without continuous liquidity mining. This is known as “protocol pwned liquidity” (POL).
Also, FEI and FRAX have partnered with Ondo Finance, which provides liquidity pools to protocols looking to list their governance token in an IDO – initial DEX offering. The protocol deposits its governance token in a pool, which is matched by either FRAX or FEI stablecoins. The Frax and Fei protocols earn 5% APR on the liquidity it provides. This is like renting out stablecoin liquidity so that other protocols can quickly get up and running selling their governance tokens.
If you enjoy videos over reading when it comes to online learning then checkout the course on YouTube. This is part 10 of 10 in the DeFi for UX Designers Course. Also, make sure to stay tuned for future Web3 Design Courses, which will cover emerging Web3 product categories.