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.

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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

Available on SSRN

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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