Automated Liquidity Management Protocol controlled by DAO
Pathway (PW) is a DAO-based approach to automated management of so-called POL (protocol-owned liquidity) with the potential to become a new standard of liquidity management. We believe that the implementation of such mechanics can increase market efficiency and prosperity of DAO systems and their token holders through positive feedback loops that correlate with the fundamental growth factors of a token.
In various applications where digital assets are used, their utility may differ within the product itself: the most common examples are staking, collateralization, governance, fees distribution, or playing a role of native token. Two fundamental factors that are usually measured for utility assets are liquidity and volume.
Liquidity measure represents an amount of capital that can be liquidated or acquired without a significant impact on the market. This is one of the most important fundamental indicators of asset health, as it shows market depth or how much active capital has already entered the system and is used in it. The more liquidity, the greater the capacity of capital that can be invested in an asset, and the higher the safety and freedom of action for an investor.
The value of a utility token is indirectly reflected in how much activity is performed with the asset. In financial protocols, trading volumes are a direct metric of activity around an asset.
Having started as an alternative to liquidity mining (AMM LP), DeFi 2.0 approach is deemed more promising and fundamentally stable. It is based on creating systems that can coordinate within a DAO structure to collectively manage capital in a treasury and liquidity on the market by solving the main problem that contributes to the instability of financial protocols: prisoner's dilemma. DAOs are capable of negating such economic side effects, as they allow for the creation of robust governance institutions and higher-level protocols, which is necessary for efficient Digital Capital Markets.
DAOs are rule-setters for algorithmic systems rather than the systems themselves. When it comes to market making of project tokens or liquidity management, algorithmic systems are needed that will operate in a fully automated manner, but with an ability to be customized and updated through social consensus DAOs. Each such DAO has a treasury which stores assets (PCA, protocol controlled assets) or liquidity (POL, protocol owned liquidity). The last two terms are the basis of DeFi 2.0, but we are expanding their meaning through the introduction of the term Pathway, which is an algorithm for management of the PCA and POL, based on a set of rules and algorithmic parameters which are subject to voting of the DAO.
This article describes the Pathway protocol, primarily how the token value is linked to the fundamental indicators such as liquidity and activity (volumes).
The mathematical relation between liquidity and the ratio was deduced based on the analysis of fundamental stats of prominent DeFi projects, such as ANY, OHM, TOKE, and a few others.
To suggest Pathway parameters for the v1.x settings we used OlympusDAO ($OHM) as a reference.
- DeFi 2.0 with same POL model
- Most (> 95%) liquidity on DEXes (Sushi)
- 11 Dec
- Liquidity: $11mln 2% Market Depth → $0.55 bln AMM TVL on Sushi (DAI, ETH, WETH pools)
- MCap: $3bln
- Vol: $90mln
Let's assume that our time target is 20 epochs. Epochs are weeks or 10 days periods. No strict planning is possible due to market volatility, so we should build upon some rough timing assumptions. These parameters are being established for 180+- days, or half a year. The overall time period of Pathway activity is irrelevant because in reality the achievement of the target can take a longer or shorter period depending on the market, community, and team performance.
Assuming that we have 25% of GTON in circulation during Pathway (PW) operation, which includes EB, current liquidity, and Ops & SPI allocations aimed to maintain PW and various supportive features (bonding, Candy and IDOs).
Based on the analysis of the $OHM case, we’re aiming to reach $3bln MCap, thus the max target for PWPeg (Pathway Peg Price - MaxPWPeg) is $600 per $GTON.
Other parameters are following a similar logic, therefore:
- MaxPWPeg = $600
- MaxLiq = $550 mln
Thus, the liquidity-only version of Pathway is deducted based on the following formula:
PWPeg (L) = FloorPWPeg + MaxPWPeg*(L/MaxLiq), where L is current GTONs liquidity.
For practical implementation we also have to define "tuning" parameters:
- SmoothingFactor for L - "alpha" parameter exponential averaging of price and liquidity data provided from oracles. We need averaging to prevent PW manipulations from external malicious actors.
- PegActionFrequency - how often SC will peg the price to the PWPeg
- VRF parameters - randomizer parameters to prevent malicious arbitrage activity.
Since liquidity is put in the BASE & QUOTE pair, it grows if there is a growing demand for the BASE token. Thus, the actual mathematical dependency represented by this function isn’t linear, but rather parabolic and depends on the ratio itself.
There exist a number of potential issues that can emerge when implementing Pathway in practice, including but not limited to determinism, the influence of arbitrage, and the risks of manipulation and frontrunning.
In order to mitigate those issues, the system should be adjusted by introducing randomness into the actions that the DAO conducts with the Treasury. For instance, using VRF (verifiable random function) oracles is possible to determine if an action (buy or sell) should be done at the current block.
Another issue that is likely to be encountered is manipulation during the early stage of low liquidity and volume. To prevent this, moving averages, such as the exponential moving average, can be applied. Also, a temporary moratorium for launching Pathway can be introduced by the DAO to lower the risk of such manipulations.
In addition, it is important to note that this protocol can be implemented independently on different blockchains, with arbitrageurs synchronizing the volume, liquidity and price across all chains. A special DON (decentralized oracles network) is planned to be used to synchronize smart contracts between blockchains.