Opportunities brought by Uniswap V3 to governance token distribution along with liquidity mining

1. Introduction to Liquidity Mining and Token Distribution

The prosperity of the DeFi ecosystem is inseparable from the innovative mechanism of governance token distribution brought by liquidity mining. In June 2020, the decentralized lending platform Compound first launched its governance token- COMP, and ever since then, the term ‘liquidity mining’ has been doing the rounds within the cryptocurrency world- owing to the factor that Compound now rewards all users who lend and/or borrow digital assets with COMP tokens. The protocol divides the rewards by 42.3% between both of the groups in the next 4 years.

  1. The first is the fair launch of tokens and community governance, thus to break the traditional disadvantages of ICO and IEO;
  2. The second is providing incentives and subsidies to accumulate users and liquidity in the early stage of the business liquidity mining, like above-mentioned Compound and Sushiswap, subsidizing users who provide liquidity for early lending and trading;
  3. The third is to provide liquidity and price support for the project’s own governance token. It helps form a positive expectation of community development and enhances the booming up process of token.

2. Economic analysis of the governance token distribution with liquidity mining in Uniswap V2

Uniswap V2 created CFMM (Constant Function Market Maker) mechanism and put it into practice. Its core feature is to keep the constant product of the two token reserves in the pair, that is x*y= K. This mechanism is simple and reliable, earning the trust of liquidity providers with Billions of Dollars. Famous decentralized exchanges like SushiSwap, PancakeSwap, QuickSwap also adopts CFMM mechanisms.

3. Opportunities brought by Uniswap V3 by providing half of liquidity to token distribution

Compared with V2 only allowing LP to provide liquidity in the full price range from 0 to positive infinity, Uniswap V3 brings more options to LP. Uniswap V3 provides range order mode that allows LP to be within a certain price range and LP could provide liquidity on single side, which perfectly solves the obstacle in Chapter 2. Therefore, in the view of the governance token distribution along with liquidity mining, choosing the V3 mode allows LP to only provide single-side “buying” liquidity below the current price, including the price range as below:

  1. From zero to current price
  2. From a certain price to the current price
  3. From zero to a certain price (lower than the current price)
  4. From a certain price to a certain price (lower than the current price)

3.1. Single fixed price range strategy:

For example, the governance token is distributed to the liquidity mining price range (0,100) , and the token distribution subsidy is evenly distributed according to the liquidity provided by LP in this range. That means the price range order (100,inf) is not subsidized.

3.2. Multiple fixed price range strategies:

According to the above analysis, we find that with the current price changing, a single fixed range may no longer meet the needs of communities. For example, if the price has risen too high and been far from the upper bound of the fixed price range, a large proportion of USDC liquidity can not be traded and used. At this time, the project can add a new fixed price range to subsidize according to the changed current price, thus forming a situation where multiple fixed price ranges can be rewarded . The flexibility of Uniswap V3 supports this strategy.

3.3. Variable price range strategies:

The above single or multiple fixed price range strategies can meet most of the V3 model liquidity mining subsidy strategy setting requirements, but there are still difficulties in the mechanism that is lagging due to current price changes or frequently needs to be adjusted, especially in the community governance vote model. If every adjustment requires a community vote, the cost of governance is too high, which may affect the development of the platform. Therefore, we propose a novel scheme based on the subsidy strategy of variable price range, that is, the upper and lower bounds of the subsidy price range are constantly changing, and the most standard can be set to , where is the current price.

4. Conclusion

The strategy of governance token distribution along with liquidity mining is worth discussion and the strategies with Uniswap V3 could solve the incentive problem faced with many projects. The distribution mechanism for NFT held by liquidity providers in Uniswap V3 is still in its infancy, and more practice is needed to verify its effectiveness.

Reference:

[1] H. Adams, N. Zinsmeister, M. Salem et al., Uniswap v3 Core, 2021. https://uniswap.org/whitepaper-v3.pdf

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iZUMi Finance

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