Author: @!0xWang1| @RealResearchDAO
Foreword
Since the beginning of the Curve War, DeFi applications seem to have entered an endless battle for liquidity. On the main battlefield, Curve, various stablecoin protocols attempt to compete for the control of veCRV in order to obtain more CRV inflation reward weight, attracting more stablecoin funds to enter their respective asset pools to increase the depth for exchanges.
Overall, the essence of Curve War is to compete for the liquidity of CRV to guide the flow of stable currency assets. Solidly, which was recently launched by the founder of YFI, also controlled the weight of the token reward issued by Solidly by controlling the veNFTs that it issued. This weight can help DeFi applications attract more assets and direct users' funds.
Whether it is the occurrence of Curve War or the emergence of Solidly, it implies that DeFi applications have unreasonable use of liquidity, including low capital efficiency. Some DeFi applications are even facing the problem of liquidity exhaustion. How to improve liquidity and manage liquidity reasonably has become an urgent problem to be solved in the DeFi industry.
A liquidity management protocol called Tokemak emerged during the liquidity battle, with the app claiming to be able to steer liquidity “where it should go,” aiming to become a liquidity provider and professional market maker for DeFi applications.
The Liquidity Pain of the DeFi World
Currently, much of DeFi is in a state of being composed of decentralized, unpredictable, and expensively sourced liquidity. The builders of new projects bear huge costs, the dual currency pool also has the risk of liquidity drying up. And due to the impermanent loss of AMM, providing 1:1 matching liquidity is expensive for both individual investors and the project parties.
Traditional market making solutions are opaque to native DeFi builders, and liquidity is highly concentrated and expensive.
Lack of liquidity can lead to poor pricing and volatility, which can negatively impact projects/DAOs that are looking for deep liquidity for their tokens who experience slippage due to trading price impacts.
Additionally, protocols that interact with other project tokens require reliable liquidity.
Integration of ideas, Tokemak's way of management
Tokenak is a new DeFi liquidity management protocol designed to generate deep, sustainable liquidity for DeFi and future tokenized applications by allowing control over where liquidity flows go.
Tokemak can be considered as a decentralized market-making platform and a liquidity regulator. It absorbs liquidity by rewarding stakers in a "Liquidity-as-a-Service" (Laas) manner, and then votes the liquidity. The distribution of liquidity to different decentralized exchanges actually appears in the role of asset management, which separates DeFi’s liquidity provision and market making. Tokemak allows users to stake single-currency assets to the protocol and vote with $TOKE tokens to control where liquidity goes.
Team details
Tokemak originated from a DeFi liquidity market maker project called "Fractal".
Tokemak core team members include:
Carson Cook (@LiquidityWizard(https://twitter.com/LiquidityWizard)): PhD in Physics, MS in Electrical Engineering, worked in fintech at McKinsey and has experience in foreign exchange market trading. Beginning in 2017, Carson began to get involved in the field of cryptocurrency market transactions. In early 2018, Fractal was founded as a DeFi market maker to provide liquidity services for decentralized exchanges. It has been running for more than three years. The origin of Tokemak is the market maker experience from Fractal.
- Bruno: Worked in a Fortune 500 technology company, mainly responsible for designing the tokenomic model of Tokemak.
- Craig: Has many years of experience leading business development and marketing for technology startups.
- Paul: Responsible for design and community work.
- 0xMaki: Sushiswap's 0xMaki announced on November 24 that he would join as the chief strategic advisor.
Financing
Tokemak raised $4 million in a funding round led by Framework Ventures in April 2021. Coinbase Ventures, ConsenSys, Electric Capital, Delphi Ventures, and North Island Ventures also participated.
Tokenomics
Tokemak's governance token is $TOKE, with a total supply of 100 million
- 30,000,000 TOKE (30%): reward release (24 months release)
- 5,000,000 TOKE (5%): In the "Cycle Zero" DeGenesis event and CoRE (Reactor Mortgage Event), TOKE will be issued for the first time
- 9,000,000 TOKE (9%): DAO reserves, these reserves can be used to exchange non-Token assets in the communication of "DAO TO DAO".
- 16,500,000 TOKE (16.5%): Contributor (12 month cliff + 12 month linear release)
- 14,000,000 TOKE (14%): Team (12 month cliff + 12 month linear release)
- 17,000,000 TOKE (17%): Investors (12-month cliff + 12-month linear release)
- 8,500,000 TOKE (8.5%): DAOs & Market Makers (12-month cliff + 12-month linear release)
It is worth noting that compared with other projects, Tokemak uses fewer tokens for rewards, most of which are concentrated in the project team, contributors, and investors, with a high degree of centralization.
How does Tokemak work?
Tokenak should be a product for businesses, serving the liquidity needs of DeFi applications. It claims to provide a "simpler, cheaper" way to obtain liquidity for DeFi applications, so how does it do that?
Token Reactors
When users provide liquidity in DeFi, they need to hold two assets, A and B. If they only hold a single asset of A or B, they often need to match A or B according to the price ratio of the two assets, such as 30% of the other asset. Assets A are exchanged for assets B, and then paired as A-B to provide liquidity. If the prices of A and B assets fluctuate, users need to bear impermanent losses when providing liquidity, which means that when withdrawing liquidity, the number of A and B assets after withdrawal will be less than the amount originally provided.
Tokemak has created a "reactor" concept that guides liquidity. This "reactor" is an asset pool created by Tokemak for each liquid asset. Different from the previous LP (A-B) matching mode, the "reactor" asset pool is composed of two roles, "liquidity provider (LP)" and "liquidity leader (LD)". LP is mainly responsible for providing assets, and LD is mainly responsible for guiding the flow of liquidity.
Liquidity Provider - LP
The LP user on the left only needs to deposit a single token X into the "reactor" to obtain a certificate tX. When exiting, 1tX=1X. And the tX certificate can be liquid traded and can be held by anyone, which also means that the liquidity of LP is not restricted by staking. During the liquidity provision period, the income obtained by the “reactor” asset providing liquidity to the outside world will be directly deposited into the token application and managed by a dedicated community organization. The only reward for LPs for providing liquidity is Tokemak's platform token, TOKE.
Liquidity Leader - LD
By staking TOKE to control the directions of liquidity, that is, staking TOKE into "reactors" of different assets to obtain the right to stake, and the right to stake has voting rights, which can determine which DeFi application the pair of liquid assets in the "reactor" can enter. LD will also receive TOKE rewards. The "reactor" diagram above shows that LD can channel liquidity into Uniswap, Sushiswap, Banancer, and 0xProtocol.
Tokemak cancels the mechanism of providing liquidity by a single user pairing A and B, allowing two types of customers (LP/LD) to put their own assets into the "reactor", which is used to pair various assets to form a liquidity pool for DeFi applications to provide liquidity. It seems to be the "single-token mining" function of Smart Pool, but the difference is that where this liquidity go is not determined by Smart Pool, but by LD. However, all the income generated by the liquidity guidance is owned by the Tokemak treasury, and LP/LD users only receive TOKE token rewards.
The Balancing Mechanism of Tokemak Reactor
Tokemak's single reward mechanism will cause an obvious problem: the role mechanisms of LP and LD overlap to a certain extent.
When LP users add tokens into the reactor and get TOKE token rewards, users have two new options at this time: stake the rewarded TOKE to become a member of LD, or sell the TOKE directly. However, if there are too many users who sell TOKE, the whole system will face the problem of the lack of LD responsibility and the excessive selling pressure of the currency price. How do balance this mechanism so that both LP and LD actively participate in the reactor?
Tokemak adopts Dynamic Yield Balancing Mechanism to automatically balance the supply and demand relationship of liquidity providers (LP) and liquidity leaders (LD) to the optimum, without the need for the community to decide each incentive strength of the reactor.
The Balance of Variable APY
If there is a large amount of ABC token assets deposited to the left side of the reactor, and the liquidity leader on the right has a smaller amount of TOKE staked, the annualized yield (APY) will increase on the liquidity leader (LD) side of the reactor, thereby encouraging LD to stake more TOKE and participate in guiding this liquidity. Conversely, if a large amount of TOKE is staked in the right side of the reactor, but the deposited ABC token assets are too small, the liquidity provider (LP) of the reactor will receive a higher yield (APY) to incentivize more token assets to be deposited.
The reactor creates a "balance" between the value of the deposited asset and the staked TOKE through variable APY incentives.
If there is a large amount of assets deposited into a given reactor (the left side of the reactor, i.e. LP behavior), and the amount of TOKE staked by the right LD to direct that liquidity is relatively small, the yield (APY) will increase on the LD side of the reactor, encouraging LD to stake more TOKE and participate in guiding this liquidity. Conversely, if a large amount of TOKE is staked in the right side of the reactor (LD behavior), and at the same time the left side LP has less deposited funds, then the LP side of the reactor will get increased APY to motivate users to deposit LP assets .
The Essential Singularity
Based on this mechanism, the TOKE income obtained by liquidity providers and liquidity leaders is not linked to the liquidity income obtained on DEX, but is simply supported by Tokemak's own dynamic balance mechanism and TOKE tokens. This breaks the traditional market maker revenue model, and when Tokemak provides and guides liquidity for DeFi applications, it is also earning DeFi governance tokens to gain voting and governance rights. Voting rights will likely lead more DeFi assets into Tokenak. The platform can store the obtained liquidity income as a protocol master asset (PCA) and accumulate continuously.
According to the design of the Tokemak project, when the PCA accumulates to a certain amount, it will reach a singularity moment: Tokemak no longer needs to attract external funds to invest in DEX to obtain liquidity mining income, and can directly use the PCA accumulated by the DAO treasury. At this time, TOKE tokens will also stop being released. And in traditional blockchain projects, the "value" of most protocol treasuries is only reflected in the market value of their own tokens. But if the token is sold, the treasury will also become worthless. As the singularity approaches and materializes, the treasury value of the Tokemak protocol will consist of non-TOKE assets, effectively making TOKE an index of the various assets it supports.
At that time, the TOKE token will also become a must-have token for all parties to compete for liquidity, just like the CRV in the Curve War.
Interestingly, referring to the bribery mechanism of CRV/CVX in Curve War, Tokemak's own trading market Votemak (https://votemak.com/) allows participation in C.o.R.E(COLLATERALIZATION OF REACTORS EVENT), that is, the project party of the Reactor mortgage event bribes the $TOKE holders. With the accumulation of PCA assets, it is conceivable that in the future, $TOKE holders will not only capture the value of voting rights, but also enjoy higher project bribery benefits.
Tokemak's protection mechanism to avoid impermanent losses
In addition to better balancing the directions of liquidity, Tokemak provides sufficient protection for LP users who add liquidity, preventing LP users from losing their interests due to impermanent losses caused by transaction-to-currency price fluctuations.
For the impermanent losses that LP users may suffer, Tokemak has designed a compensation waterfall mechanism to ensure that any losses can be compensated:
When impermanent losses occur, the first layer of protection for liquidity providers is provided by Tokemak's reactor reserve pool;
Then, the rewarded TOKE and staked TOKE of the liquidity leader (LD) in the reactor are retrieved for the second and third layers of protection.
Typically, liquidity providers are staking assets to earn some passive income from the protocols, while potentially taking on the risk of impermanent losses and liquidation. On Tokemak, LP can lend its assets to LD through the Tokemak protocol. Combined with the protection mechanism of Tokemak, for liquidity providers, they can safely earn some income. And at the same time, there are opportunities to influence the decision of the protocol.
Essentially, Tokemak did not erase the impermanent losses suffered by LP users out of thin air, but compensated the LD money to the LP. This mechanism also helps hold decision makers (LDs) accountable for their own decisions. In Tokemak, if LD does something irresponsible, LPs can still get their money back safely, and LD's earnings will be cut.
As a well-meaning protocol also for impermanent loss protection, Tokemak shares many similarities with Bancor:
In the latest Bancor V3 announcement, Bancor also announced optimizations to its impermanent loss protection model:
In BancorV2.1, users can enjoy impermanent loss protection in the fund pool related to whitelisted tokens. However, the protection ratio is 0% within 30 days of staking, 30% on the 30th day, and thereafter the impermanent loss protection ratio will increase with the duration of the staking period, increasing by 1% every day. And users can enjoy 100% impermanent loss protection after 100 days of staking.
BancorV3 allows users to obtain 100% impermanent loss protection on the day of staking, avoiding impermanent losses to the greatest extent.
In the previous version of Bancor, the impermanent loss protection will first use the fees obtained from the liquidity of the protocol as the first defense. If the impermanent loss exceeds the fee, it will be covered with newly minted BNT as the second defense against impermanent losses.
In V3, Bancor enabled the function of “third-party projects provide impermanent loss protection for LPs”, so that Bancor project parties do not have to bear the impermanent losses of users alone, and the pressure reduction can allow Bancor to support more impermanent losses of project tokens that are protected by the pool of funds.
Compared with Bancor's continuous optimization of its own impermanent loss protection line of defense, Tokemak has shared impermanent loss protection to the project party (LD) to a certain extent from the beginning, but in a more natural way than Bancor, and this also allows LD to be at the decision-making level to be responsible to the LP side.
Under the comprehensive protection, what is the LP income of Tokemak?
(The LP income of Tokemak and other major DEXs. Source: DefiLama)
It can be seen from DeFiLama data that compared with major DEXs like Lido and Curve, the APY obtained by users for providing liquidity in Tokemak is relatively objective, and the APY dynamically balanced by Tokemak Reactor is also in the range of 2%-8%. On the premise that only a single currency is required to be deposited, the deposit certificate can be traded, and the project provides multiple protections against impermanent losses, Tokemak can still provide users with considerable annualized income.
However, compared with major projects, Tokemak's TVL is relatively small. If there is a large influx of funds and under extreme market conditions, whether Tokemak's smart contracts can withstand the test from the market remains to be seen.
Challenges and Risks Tokemak is Facing
A Double-edged Sword of Compensation Waterfall
To better protect the rights and interests of LPs and attract more liquidity, Tokemak has designed a compensation waterfall with multiple guarantees. But while protecting LP users, this intimate compensation mechanism essentially transfers the risk of impermanent losses suffered by LP users to LD and the project itself. When encountering extreme market conditions, impermanence losses become large, and the losses suffered by TOKE also increase immediately, and the downward pressure on TOKE will also increase. For LDs, the leverage value that TOKE can bring to them is the most important. When the TVL in the pool falls sharply, the leverage value of TOKE will also drop. Coupled with the risk of impermanent loss faced by the protocol, it may lead to the death spiral of the token’s price. When the price is not recognized by the market, the overall agreement will also fail.
An Over-centralized Token Distribution
$TOKE allocated to investors and teams accounts for nearly 50% of the total supply. The DAO Reserve holds only 9% of the supply. At the end of the reward distribution, if the project does not achieve a singularity to break away from the TOKE token governance and control other protocol tokens to form a positive cycle, Tokemak's ability to rely on its tokens to continue to drive growth may be limited.
Still-to-be-tested Smart Contracts
Tokemak's unique liquidity management mechanism uses a large number of innovative and complex codes and models. Although Tokemak's smart contracts have been audited, whether they can successfully run smoothly in various emergencies and whether they can successfully resist hacking still needs to go through a test of time.
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