GTON Academy. Tackling the Liquidity Issue With Pathway - GTON Capital

Let's look at how GTON DAO's Pathway, based on the protocol owned liquidity (POL) and protocol controlled assets (PCA) concepts, can help solve the liquidity issue faced by many protocols.

Innovation in the DeFi space never seems to stop, and new projects are constantly launched, issuing their tokens. However, when it comes to liquidity for their tokens, things are often far from rosy for protocols, as attracting liquidity to a new token is tricky.

Liquidity challenge

Anyone can, for instance, create a pool for their token on SushiSwap. However, once a pool has been created, the token's issuer has to make sure that users bring sufficient liquidity to that pool. Clearly, insufficient liquidity translates into high transaction fees, which, in turn, result in poor user experience.

Therefore, token issuers incentivize users to participate in their pools by rewarding them with tokens. As a result, a "race to the bottom" starts between pools, meaning that they have to offer yet higher rewards to liquidity providers, issuing more and more tokens and thereby diluting the protocols' value.

Plus, this model is not exactly sustainable, as users can easily take liquidity from one pool to another that offers higher rewards.

DAO as a solution

What could be done to solve this issue? One possible approach is control over liquidity through the treasury of a decentralized autonomous organization (DAO). DAOs can mitigate many issues, as they facilitate the creation of sustainable governance tools and processes.

DAOs cannot replace algorithmic systems, but what they do is set and enforce rules for systems of that kind. Algorithmic systems needed, for instance, for market making of protocols' tokens or liquidity management, need to operate fully automatedly, but with an option for customization and updates through DAOs.

POL

In managing protocol liquidity, the concept of protocol owned liquidity (POL), originally pioneered by Olympus DAO, can make a difference.

In that model, instead of relying on offering incentives to users to provide liquidity to pools, the "bonding" mechanism is used. In the bonding model, a protocol sells its tokens at a discount to users, who, in exchange, provide another token, such as, for instance, ETH. Tokens provided by users form the protocol's treasury and, in turn, can be provided to DEXes to earn additional revenue for the protocol.

Bonding explained

For instance, a protocol that issued the token XYZ offers to sell it with a typical discount of 5-10% for other tokens – say, ETH or DAI. Similarly, a user could buy liquidity pool tokens (XYZ/ETH) with a comparable discount. As opposed to buying tokens in the market, a user 'bonds' tokens, which are vested over a certain period (normally, under a week) to rule out immediate arbitrage opportunities.

The bonding process enables protocols to acquire a large number of valuable tokens in their treasury. To a large extent, this process is similar to a situation when a country's national bank sells the country's currency – the issuance of which it controls - for foreign currencies to create reserves.

DeFi 2.0

Lately, POL has often been referred to in the context of DeFi 2.0, a model that also involves the concept of protocol-controlled assets (PCA). DeFi 2.0 has been welcomed as a more promising and stable alternative to liquidity mining (AMM/PMM LP). DeFi 2.0 is based on the idea that a protocol's liquidity is managed by a DAO, which has a treasury storing the protocol's PCA and/or POL.

GTON DAO furthered this model by introducing the concept of 🧬Pathway, an algorithm for managing PCA and POL, based on a set of rules and algorithmic parameters voted for by the DAO.

If a protocol's DAO controls all liquidity for the protocol's token, it can easily create a transaction that atomically removes liquidity from a DEX, adjust the QUOTE/BASE ratio to a required level and add liquidity back afterwards. The QUOTE/BASE ratio shows how much the BASE token costs in QUOTE in a particular pool. For instance, for a GTON/ETH pool, BASE is GTON and QUOTE is ETH.

Thus, DAOs can do proactive strategic market making on DEXes. For instance, if demand for an asset is too high, the DAO can increase the amount of QUOTE token by selling BASE against QUOTE.

Through these seemingly simple buy and sell activities the DAO can manage the DAO token price.

🧬Pathway

Now, introducing Pathway, which is the ultimate tool for facilitating the stability of the DAO through the DAO token pricing. Technically, Pathway facilitates determining a proper QUOTE/BASE ratio in the pool for pegging the price to a certain minimum and inclining it to grow within a specific range.

Before implementing Pathway, such issues as determinism, arbitrage and risks of manipulation and frontrunning needed to be dealt with.

To mitigate those issues, a system has to be adjusted by introducing randomness into the actions that the DAO conducts with the treasury. For instance, the use of verifiable random function using (VRF) oracles is possible to determine if an action (buy or sell) should be done at the current block height.

Another issue is manipulation at the early stage of low liquidity and volume. To prevent that, moving averages, such as the exponential moving average, can be applied. In addition, a temporary moratorium on launching Pathway can be introduced by the DAO to lower the risk of such manipulations.

Importantly, Pathway can be implemented independently on different blockchains, with arbitrageurs synchronizing the volume, liquidity and price across all chains. In that case, a decentralized oracles network (DON) needs to be used to synchronize smart contracts between blockchains.

To achieve long-term stability of a protocol's tokenomics, tokens need to be attracted to the treasury. The bonding mechanism, described above, is used here, and users are still getting rewarded (in the bonding case - in a form of discounts) for providing liquidity to the treasury. Thus the DEX liquidity is still in a way provided by the community but in an accumulated way through the treasury. The latter becomes the majority owner of the LP tokens on the DEXes which allows for consolidated liquidity management and treasury replenishment with the LP rewards.

When the DAO owns a majority share of LP tokens, it becomes possible to execute fast liquidity maneuvers to adapt to the ever-changing market and therefore pursue the dynamics of the token's fundamental metrics and establish a direct token value correlation.

Final thoughts

Pathway has the potential to become a new major model for liquidity management. The use of Pathway 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.