Sustainable DEX Token Liquidity: A Structured Products Framework
Current crypto liquidity models often lead to unsustainable token economics, plagued by mercenary capital and inefficient risk allocation. This presentation introduces a novel framework leveraging structured products tailored for DEX token markets to create sustainable liquidity, especially for long tail assets. By separating capital provision from risk-bearing, crypto protocols can reduce dilution while ensuring stable returns for liquidity providers.
The Liquidity Trap: Pump.fun's Nihilistic Triumph
1
Crypto's Liquidity Problem
Long tail assets face challenges: CEXs are gatekept and costly, while DEXs require token incentives and lead to LPs losing money.
2
Pump.fun's Approach
Treat everything like a ponzi, providing instant liquidity for any token and propelling Solana to challenge Ethereum.
3
Call to Action for Ethereum
Innovate or risk losing ground. Match Pump.fun's liquidity while prioritizing sustainable value creation, responsible risk management, and decentralized trust.
LP Risks Quantified
Black-Scholes Analysis Framework
Analyzing the risk through the Black-Scholes lens see [1].
Liquidity Formula
Lt = 2 D sqrt(St)
Hedging Implications
As is the case in all derivatives, including exotic ones, we can hedge μ, but not
Write Options on LP collateral
Options on LP Tokens
We can create options on LP tokens, which are derivatives on derivatives, in closed form. Calls and Puts are just exotic options.
Token Primitive
Use these options to build a token primitive that moves risk away from Liquidity Providers to the Token issuer.
Risk Transfer Construction
1
Liquidity Providers' Goal
Liquidity Providers want less risk (orange line in the graph).
2
Desired Payoff
A payoff with 75% downside protection (blue line in the graph).
3
Construction
Bond + ATM-LP-Call 2 x OTM-LP-Puts (blue line)
4
Hedging
Hedge statically with LPx2 as collateral (green line)
Summary of New Primitive: LP Note
1
Project Issues LP Note
The project issues a Liquidity Protection note (a bond-like ERC20 token)
2
LPs Buy Note
Liquidity Providers buy the LP note and contribute ETH/USDC
3
Create DEX Pool
Project combines tokens with ETH/USDC to create a DEX pool
4
Collateral
The pool, LPx2, serves as collateral, which is always bigger or equal to the note payoff
5
Locked TVL
The collateral (TVL in the DEX pool) is locked until maturity
Possible Market Structure Realignment
TradFi Transformation
Index funds fundamentally altered stock market investing by enabling passive strategies to outperform active management, democratizing market access for retail investors. They now dominate equities TVL, accounting for about 50% of U.S. fund assets by 2023.
Crypto Parallel
Structured products are poised to create a similar paradigm shift in crypto by allowing passive strategies to potentially outperform active approaches and opening doors for mass adoption by lowering barriers to entry. Projects are willing to subsidize passive investors through structured products, as stable liquidity is highly beneficial to the project's ecosystem.
What we are working on
These images showcase the various aspects of our ongoing work in developing structured products for DEX token markets, including risk management tools, liquidity provision strategies, and innovative financial instruments.
Thank you!
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Research Papers
For more information on our research and developments in sustainable DEX token liquidity, please refer to our published papers on SSRN. We welcome collaborations and discussions to further advance this field.
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