With DAOs gaining in popularity, there are growing questions around how they can effectively manage their balance sheet while building healthy and sustainable liquidity in their native token.
A strategy employed by DeFi protocols to build liquidity in their tokens is to add “liquidity mining” rewards to their pools as an additional incentive for users to deposit tokens. In addition to earning a percentage of trading fees generated by the pool, depositors also earn a share of the pool’s rewards.
What’s the catch with Liquidity Mining?
Liquidity mining has proven largely ineffective at attracting sustainable liquidity in a token due to “mercenary” yield farmers who go from pool to pool “farming and dumping” token rewards. Once rewards in a given pool expire, these opportunistic farmers tend to withdraw their tokens and move onto the next pool offering rewards.
A key reason why even loyal token holders are reluctant to hold their tokens in a pool after rewards expire is because of the risks associated with liquidity pools. The main risk, known as divergence loss or “impermanent” loss, occurs when the price of paired assets in a pool diverge. The price divergence may leave you holding less of the token that increased in price and more of the token that decreased. Over time, this can cause the cumulative value of your pooled tokens to be worth less than simply holding the assets in your wallet.
Impermanent loss inhibits broad and sustainable involvement in decentralized liquidity pools and causes holders to flee pools when rewards expire.
Nice Try, “DeFi 2.0”
A new wave of so-called “DeFi 2.0” protocols have sought to introduce alternative models to liquidity mining. One approach encourages DAOs to sell discounted tokens (via “bonds”) in exchange for pool tokens. Through this process, the DAO receives pool tokens in its treasury, which represent fee-generating shares in its pools, accruing what has been called “Protocol-Owned Liquidity” (POL).
While DAOs seeking to “own” their liquidity is generally a positive trend for the industry, the current approach to POL has shortcomings. Among them is the fact that while a protocol may “own” their pool tokens, the pool tokens are still exposed to Impermanent Loss, while the effects of mercenary liquidity are only barely curtailed. In the case of “bonds”, the protocol offers to sell its tokens at a mark-down in exchange for pool tokens. This creates an arbitrage opportunity that leads to slow but persistent value loss in the acquired pool tokens. As the token price falls vs. the counterpart (e.g., ETH) due to the bonding process, the protocol suffers negative returns and depletes its treasury, while debasing its token value. Ultimately, the protocol has painted itself into a similar corner as it does with liquidity mining.
The ultimate solution: Single-Sided Staking on Bancor
In late 2020, Bancor launched an experimental new model for decentralized liquidity called Single-Sided Staking, which offers depositors 100% protection from the risk of Impermanent Loss. Combined with single-token exposure, Bancor’s Impermanent Loss Protection has helped the protocol attract upwards of $2b in total value locked (TVL), and generate millions in fees per month for LPs.
Single-Sided Staking offers a unique proposition to DAOs: Generate protocol-owned liquidity that is protected from impermanent loss. DAOs deposit their treasuries in Bancor and receive pool tokens that produce on-chain yield for the DAO with full “risk-on” exposure to their token — without subjecting treasury funds to value leakage from IL.
The result is users won’t flee pools after rewards programs end because they know they are protected. This incentivizes long-term holders to participate in community-sourced, decentralized liquidity, rather than liquidity being held hostage by “mercenary” farmers who are known to farm and dump their earnings, and withdraw their liquidity when traders need it the most.
Conclusion
Bancor’s Single-Sided Staking offers a safe and reliable solution to generate yield for DAO treasuries in an open and transparent manner with token communities involved alongside DAOs as passive liquidity providers. The participation of both the DAO and its token holders in decentralized liquidity provision helps the protocol maintain healthy price discovery in the native token and creates a powerful community-owned resource for generating passive income and distributing on-chain value.
Bancor has now attracted the deepest decentralized liquidity for major tokens including LINK, SNX, BAT, ENJ, wNXM and more. Average annual yields on Bancor have ranged from 5–60% in recent months, with over $200m paid to liquidity providers in the last year. DAOs that have recently staked treasury funds on Bancor include: UMA, Paraswap, KeeperDAO, BarnBridge, Harvest Finance, WOO Network, IDLE Finance, Saffron Finance & more. More than 30 projects plan to provide liquidity and incentivize pools on “Bancor 3”, the protocol’s upcoming new version.
More resources:
- Trade, stake and earn on bancor.network
- Proposing Bancor 3 (Bancor governance)
- Bancor Staking Guide
- Learn more: Bancor Staking & Impermanent Loss
- Getting Started & FAQs
- Study on Impermanent Loss in DeFi
