(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)
Written by Xulian – @KingJulianIAm
In the DeFi space there is an array of token types that exist, from bonded tokens, b or gTokens like Olympus DAO, to xTokens like the xSushi. These tokens vary their offerings from offering a cut of protocol fees to a claim of the protocol’s treasury. There are also veTokens which were used by CRV to save its token with some tokenomic innovation. Now, it seems Kujira has taken this a step further. In this article I will break down tokenomics in other protocols and how Kujira’s innovation might just be the new way forward. Even though all the protocols that we analyze have distinctly different offerings, I choose to focus on their token model rather than their whole protocol offering.
xSushi the father of protocol fee sharing
The $xSushi model was born and sparked the first vampire attack in decentralized finance (DeFi). — A vampire attack essentially takes away a protocol’s locked liquidity by offering rewards on the new protocol. Users migrate to earn the new rewards and the old protocol is left with less liquidity. — When SushiSwap forked Uniswap, it promised not only $Sushi rewards for providing liquidity on trading pairs in the platform, but it also offered a share of the fees generated by the protocol for $Sushi stakers.
If users chose to stake their $Sushi, they would in turn receive $xSushi. $xSushi takes protocol fees and buys $Sushi off the market, then it divides the $Sushi tokens amongst stakers, rewarding them for their stake. When you stake your $Sushi tokens, you essentially “purchase” a share of the $xSushi pool. Because of this, $xSushi tokens would slowly depeg and appreciate in value as it represented a bigger share of the $Sushi pot. In other words, 1 $Sushi is staked for 1 $xSushi. But as the protocol earns fees over time, 1 $xSushi becomes worth 1.2 $Sushi. This would represent a return of 20% from protocol fees, as an example.
This represented an innovation in protocol fee sharing, as well as a way for the token to have some form of “buy pressure” or demand. The issue was, that even with this demand from the protocol side, there was still $Sushi used to incentivize liquidity providing on the protocol. This caused there to be “mercenary money” that would provide liquidity in order to farm the token. However, they were not looking to hold the token. Rather, they would look to quickly sell it to get profits from the rewards on their LP positions. Welcome the farmers.
Even though $Sushi was also used as a governance token, it did not seem to matter if you held $xSushi or $Sushi for governance. This resulted in there being less incentive to hold onto the token, as the annual percentage rate (APR) on $xSushi hovered around 12%; an amount that, in crypto, does not excite many, or can be made faster by trading the token’s price swings.
Bonding, staking and wrapping: the DAO saga
In a push for innovation, Olympus DAO was formed. With it came the concept of bonding, staking and protocol owned liquidity. We also saw the birth of the famous (3 , 3) meme which represented positive game theory in the protocol. This is where users would bond and stake their tokens. Olympus was able to offer extremely high annual percentage yield (APY) for their stakers (this has ranged from over 8,000% APY now to around 900% APY). This was due to an interesting change in tokenomics. Anyone that stakes $Ohm receives $sOhm in exchange.
What is Olympus DAO & how does it work?
Olympus DAO looks to become a reserve currency of the DeFi space. Their first offering was their $Ohm token which would be backed by a basket of different assets that were held by the Olympus DAO treasury. Each $Ohm is said to be backed (not pegged) by one $Dai in the treasury. If there is more value backing $Ohm in the treasury, then $Ohm can be minted to “dilute” the value of $Ohm and bring it back closer to that backing price. For example; if there are 10 $Ohm tokens in circulation but there is 100 $Dai value in the treasury, then there can be 90 $Ohm minted in order to bring $Ohm closer towards its backing price. These newly minted tokens can then be (and are) distributed to stakers, hence the insane APYs offered by the protocol.
Next is their process of offering “bonds”. With bonds users can exchange certain assets for a discount on the market price of the $Ohm token. That token would be paid to them a few days later, effectively earning them interest like a bond. Bonding can occur with many different assets and even with LP tokens. This caused for Olympus to own almost 95% of their liquidity. Protocol Owned Liquidity (PoL) means there is no need to pay incentives for mercenaries to lend you liquidity for your token.
Now, even though the action of minting new $Ohm tokens essentially dilutes the supply of $Ohm for anyone who is simply holding the token, stakers stand to benefit as the APY they earn would outpace the dilution, and their total value would increase as it is closer tied to the total value of the treasury. Because of this confusion on tokens and dilution, $Ohm has again innovated with the concept of $gOhm. The $gOhm token tracks the value of the treasury or the Current Index and represents your total share of the treasury. It does not matter if you are earning more $Ohm from staking, rather your $gOhm represents a claim to a percentage of the total treasury.
So, let’s break it down and recap what happened with the tokenomics: first we had $Ohm, then we got $sOHM (staked Ohm). Staked Ohm grows as it earns “rebases’’ or rewards in the form of more $Ohm tokens by being staked. In its final form, we receive $gOhm (wrapped, staked Ohm). $gOhm is the V2 of $wsOhm as it allows the token to now be used on other blockchains as well. Owning $gOhm, you still collect rebase rewards just as if you had $sOhm, but you won’t see your token balance increase, because the increase in value is based on the Current Index (or treasury) at the time of purchase and sale.
With this tokenomic model, users are not only exposed to protocol fees, but also to the protocol growth overall. As the protocol grows, so does the value of your share. A problem with this model is that in order for participants to take profits, they are still required to sell the $Ohm token regardless of its wrapped or staked version. Selling will occur and price will be driven down. This plays in with the whole game theory of the protocol, as it brings the value of $Ohm down closer to its backing value of one $Dai. Remember, $Ohm can go above but not below this value.
Even though selling for profit is healthy market behavior, could anything be done in order to mitigate sell-side pressure? On the bright side, the treasury does not shrink, even when there is selling happening, as the other basket tokens remain.
veTokens, postponing the pain
veTokens have been all the rage with the recovering DeFi blue chips that are trying their best to rescue their tokens from a fate best represented by the MKR/ETH chart. With the evolutions in the Curve wars and the way Curve evolved their token to $veCRV, there was a rebirth in tokenomics for protocols that just weren’t cutting it. First, let’s understand $CRV real quick. The main purposes of $CRV are to incentivize liquidity providers on the Curve Finance platform, in addition to getting as many users involved as possible in the governance of the protocol. Currently $CRV has three main uses: voting, staking and boosting. Those three things will require you to vote-lock your CRV and acquire $veCRV. The longer you lock your $CRV, the more voting power you get.
What the veToken model offers is, in other words, a way to postpone the selling of the tokens, since they are locked for a determined amount of time in order to partake in certain activities on the platform. As we learned from the Curve Wars, users would lock their $CRV tokens to get the $veCRV, which they would use to influence the incentives toward pools that benefited their own protocols.
Now the question is: Did this solve the tokenomics? Well, one might argue it did, since it lowers the total supply of a token by locking it in a smart contract for a set amount of time. It also incentivizes participation on the platform. However, I’d say it is only postponing the selling of the token. You see, participants will always look for a way to take profits. If others lock after you, and the token appreciates in value, you have an incentive to sell before the next unlock, as you could essentially front-run the others, and then, buy cheaper if you so choose to. You end up just postponing the bleed for a later date.
sKuji: a new hope
In the same way Luke did not look like the type of character set to overthrow the Empire, we now have $sKuji. I wrote about Kujira and its dApps in this article, but let’s focus on $sKuji. Kujira’s Orca dApp is a liquidation platform that allows users to gain access to cheaper tokens by liquidating under-collateralized loans. Their token, $Kuji, is used to pay for fees, vote, and can also be staked on the Blue dApp of the Kujira Protocol suite. Even though it started like our good friends from SushiSwap, with the simple protocol fee-sharing model of $xSushi, $Kuji has recently evolved.
Now, by staking, you are instead “bonding” on the platform. The platform can then earn fees in different token types, and it is capable of growing a treasury or pool from these fees. By bonding your $Kuji on the platform, you now get a representation of ownership of the protocol’s pool. Withdrawing your ownership means you receive an equal proportion of those assets in the pool based on your $sKuji ownership, and the balances of the assets in the pool.
Bond — IN: $Kuji — OUT: $sKuji.
Unbond — IN: $sKuji — OUT: $bLUNA, $bETH, $aUST, $Kuji (and any other bASSETS to come).
This means that by bonding your $Kuji, you are essentially buying a portion of the total value of the pool. If the pool grows, so does the value of your piece of the pie, since your split remains the same. For example, if you buy 25% of the pool, and the pool grows by 2x, you still own 25%, but the value of that 25% is now worth double. This, in turn, has the beneficial effect that when users choose to cash out, they don’t only sell the $Kuji token. Rather, they take a portion of all the different assets in the pool. This helps the $Kuji token to hold up more when participants take profits, as they aren’t only selling the $Kuji token. Since this pool does not matter to the longevity of the protocol overall, it does not matter if it is emptied by profit takers, but as fees are earned, the pool grows. New $Kuji holders would be incentivized to bond to $sKuji in order to get a share of the pool’s assets. If you continue to hold your stake, you are earning protocol fees that can be redeemed at any time. Given that the protocol earns fees from top assets like $bLuna and $bEth (more assets to come), anyone looking to accumulate these assets would benefit from bonding/staking their $Kuji into the pool.
Something to note is the 24-hour unbonding period. This prevents users and bots from using the pool as a decentralized exchange (DEX) for these assets. A great way to think of $sKuji is as an automated way to be constantly buying apex assets at local bottoms, just by being in the pool.
Another benefit to staking $Kuji is the access to the advanced metrics on the Orca dApp. Some of the specific utilities for staking the Kuji token are:
- Stakers of 5,000 $Kuji or more gain access to Orca’s premium dashboard.
- Stakers of 300 $Kuji get access to the basic analytics dashboard.
- All fees and commissions earned by Kujira products are paid to $Kuji stakers in the form of the different assets that the protocol receives.
- Stakers also receive a 20% cut of interest earned by bids made using aUST while they wait for liquidations to occur.
All of this offers value and drives demand for the $Kuji token, which for now still appears to be overlooked as it is still only on the Terra blockchain. As it grows into new blockchains, I can foresee more users finding this project.
As the DeFi space evolves, it is crucial for protocols to create better value capture for their tokens. Otherwise, their tokens will just bleed into non-existence. Often I wonder, “Did this protocol even need a token?” Many could have just earned fees and moved on in their life, but given the decentralization narrative in crypto, protocols slap on a token with governance options and then say it is decentralized. However, more often than not, these governance votes are still controlled by key big stakeholders. Like in traditional companies, only the top holders matter.
The question is: How can a protocol offer some form of dividend like a traditional stock, but also use its token in a non-dilutive way to incentivize participation? Slapping on lock-up periods or a use case like governance is not enough to keep users from cashing out. Well, I guess nothing is. However, can you create enough use and value for the token that it would benefit holders more to stake and hold, rather than to try to have a short-term speculation on price? I believe $sKuji could be onto something with this type of protocol fee sharing. Not only that, but depending on the amount you stake, you also get access to advanced metrics on the Orca dashboard.