In my previous post, I expressed concerns about the approval by the Executive Committee (EC) of incentives for three pools on SecretSwap. There, I argued primarily that these approvals go beyond the ECs mandate. Here I will focus specifically on the SEFI/sXMR pool and I will argue that it is not in the interests of SecretSwap as a platform or its stakeholders (e.g., SEFI holders) to incentivize this pool.
I apologize in advance if the following is overly pedantic but I am trying to clearly and fully explain my thoughts and I want to include the complete context.
What is the basic model of an AMM? The idea is that people “provide liquidity” in that they purchase an ownership stake in the pool (represented by LP tokens) by surrendering quantities in equal value of both tokens in a given pool/pairing. The pool then allows anyone to swap using the provided liquidity provided that they pay a swap fee (0.3% usually). The price is determined by the contents of the pool (through an equation but, briefly, the pool ensures that it doesn’t run out of either token in the pairing by raising the price of whatever token is being swapped out).
This is all well and good but if there isn’t much volume in trades then there won’t be any reason to LP and then there won’t be much liquidity so no way to trade effectively so very little volume – vicious cycle.
To bootstrap our way out of this problem, LP rewards (sometimes called liquidity mining) were devised. That is, LPs will be rewarded not just with the swap fees (which are not appreciable until there is substantial volume) but also with tokens that are newly entering circulation. Now the question of what tokens and how do we get them? The answer is the token that grants governance rights to the swap platform itself. The gov token clearly has at least a speculative value that can be used to incentivize LPs, bootstrapping liquidity to get the system going. The speculative value of gov tokens is due to the implicit power to extract revenue through governance of the platform. Often, this use case goes from implicit to explicit pretty quickly. For example, Sushiswap uses 0.05% of volume (1/6th of swap fees) to buy back SUSHI tokens. This closes the virtuous cycle of value and I am in favor of a SEFI buyback but that is a separate issue.
For the present discussion, we must ask which pools need to be incentivized? Virtually all reputable AMMs (possible exceptions include Curve and Bancor which have different models – Bancor in particular being notably more complicated since technically their gov token is an LP token which is unusual to say the least) have a similar format. This format is to use the native coin as a central currency – incentivizing pools pairing with the native coin. This is the format followed by the most well-known standard-model AMMs including Sushiswap (native ETH, gov SUSHI), Uniswap (native ETH, gov UNI), Pancakeswap (native BNB, gov CAKE), and Spookyswap (native FTM, gov BOO).
At the same time, most AMMs incentivize the pool where the native coin is paired with the platform governance token (e.g., the WETH/SUSHI pool or the sSCRT/SEFI pool). This is to incentivize people to provide exit liquidity for those who will LP to other pools merely for gov token farming. The gov pool is obviously critical since without that, it becomes quite hard to cash out gov tokens and you have low liquidity/interest in the gov token and platform as a whole. After all, LP rewards are payed in gov tokens and liquidity is the source of value here – Liquidity means traders can trade without huge price impact which attracts trading volume which gives implicit value to the gov token (it’s the gov token of a platform with lots of volume so in principle it could charge fees on that volume) and a more valuable gov token further incentivizes LP in a virtuous cycle.
In the case of SecretSwap, this means incentivizing the sSCRT/SEFI pool and then using our native coin (via the wrapped sSCRT) as a central currency for swap pools. Why not use the gov token as a central currency? Well, there are people who have assets and are willing to LP in exchange for rewards but that do not necessarily want exposure to SEFI. These people are called farmers and while they aren’t everybody, they are many and we need them because they have a lot of liquidity. They are a segment of our target market because they are a group of users we want to utilize our platform.
Now, the farmers know for sure that they will receive LP rewards in the gov token (SEFI) and that they plan to sell the rewards to capture the farming yield. Thus, they know there will be some downward pressure on the SEFI price due to farming (themselves and others like them). In the case of a farmer on Etherium, “capturing the yield” means selling the gov token for ETH. Here, it becomes really clear why it wouldn’t be a good idea to use the gov token as a central currency for a swap.
If, say, Sushiswap didn’t incentivize WETH pairings but only SUSHI pairings, then they would have a much harder time attracting liquidity because LPing would carry a much higher risk of Impermanent Loss (IL). In fact, IL would be basically guaranteed once farming gets going. This is why the gov-native pool is always rewarded at a higher rate – because the IL due to gov-token price pressure is foreseen and needs to be compensated (especially early on before volume picks up). This is so much the case that these are sometimes called the “death pool” of the platform in defi degen slang (that is, the WETH/SUSHI pool or the sSCRT/SEFI pool).
All this is especially problematic initially when the AMM is a new platform – they may never get off the ground without any meaningful liquidity. In the case of a farmer on Secret, “capturing value” means selling SEFI for SCRT and then maybe also selling the SCRT for ETH or some other token. The fact that an LP potentially/probably has to trade all the way back to ETH to fully “capture value” from farming only strengthens the argument…If the risk of IL due to pairing with the gov token would suppress interest in LP even when the native coin is ETH, how much more so when the native coin is the relatively lesser known SCRT?
Just to clarify where I am coming from personally, I have like 40x as much value in SCRT and SEFI as in ETH and I don’t dump any LP rewards. I’m hugely bullish on SEFI and want SecretSwap to attract massive liquidity and trading volume. I believe that the way to accomplish that is to make our system user friendly particularly to LPs or at least not less user-friendly than LPs would be used to from other AMMs.
And that’s where this proposal comes in. By approving SEFI/sXMR incentives instead of sSCRT/sXMR, the EC makes the value proposition for a potential LP much less attractive. The prospective LP now has to convert half their stack into the same token that they will be getting as farming reward. This is a substantially worse deal than an LP would ordinarily expect from an AMM. That the EC is doing this to prospective XMR LPs might make it easier for them to swallow because XMR has been locked out of defi for so long.
Full disclosure, I’ve never owned XMR and don’t plan to LP. However, if I were in the XMR community I would feel pretty slighted by this move. As a prospective LP, it would make me feel like SecretSwap was possibly a bit scammy and I’d have to take a deeper look. That’s the same feeling I got when I started looking into Sienna with their whitelisted fund raise, overly memey social media presence, and very little else.
None of this is to knock SecretSwap; a deeper dive would almost certainly allay any fears as we have tons of meat on our bones – an active community engaged in substantive discussions, relentless devs breaking innovative ground, and solid tech with a unique value proposition and nearly limitless use cases. My point is partially just that it feels scammy. Certainly to anyone familiar with other AMMs, understandably to the XMR community if they are singled out, and likely to other prospective LPs as we continue building bridges.
It really feels like this decision was borne out of a desire to support the price of SEFI and, as a sefi holder, I’ve watched the USD value of my holdings whither over the last few months. I can definitely understand the impetus to give some price support to SEFI and ease the pain on us holders/stakers and SCRT/SEFI LPs. But this smacks of short-termism; stepping outside the established practice/principles in search of a quick fix that addresses the immediate problem without considering long-term sustainability.
Finally, I’d say that this issue is (i) non-trivial / not obvious, (ii) subject to differences of opinion, (iii) extremely important for the future of SecretSwap, (iv) liable to generate bad feelings in singled-out communities (XMR) that we want to feel welcomed. For these reasons, I don’t think it is a good candidate for unilateral action by the EC. Any moves toward switching incentives to SEFI pairings from sSCRT pairings should be authorized via governance proposals. The only such proposal so far (to incentivize SEFI/sETH) failed.