Overview
In the last post, I reviewed the potential liquidity management approaches and potential strategies. You can read Part 2: POL management protocols, potential strategies | Arrakis + Uniswap V3 here.
In this post, I’ll summarize Part 3: considerations and next steps.
POL considerations
As I noted in Part 2, any group acting as a manager for a vault that contains both treasury and non-treasury funds comes with regulatory risk along with greater counterparty risk (e.g., liability in the event of an exploit or due to market losses in USD).
It’s highly likely that the treasury and the average POOLers’ ideal outcomes for liquidity provision are drastically different, anyway. From my point of view, the USD value of the position doesn’t matter as much, as diversifying into more (W)ETH as POOL increases in price is a net benefit to the treasury. Should the price of POOL continue to fall, then buying POOL back at historic lows is also a net benefit for the protocol.
In previous governance posts, recommendations were made to use USDC as the paired asset. However, we’ve seen that POOL tends to move more closely to ETH price movements, which means that a POOL / (W)ETH pair will benefit the treasury more over time, as the two assets are more closely correlated than POOL is with USDC. (W)ETH also has deep liquidity and trades can route to other pools, such as the (W)ETH / USDC pool.
PoolTogether uses ETH for operational costs and potential liquidity provision; we can also hold ETH and benefit from potential price appreciate over time. There are also ample opportunities to earn yield on ETH over time. Having a POOL / (W)ETH pair, then, is the obvious choice.
That leads us to the other considerations we need to evaluate ahead of a POL strategy.
Fee tier
On Uniswap V3, you can select from a variety of fee tiers.
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0.01%
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0.05%
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0.3%
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1%
Members can discuss the potential fee tier, but to keep in line with the fees present in Uniswap V2, it seems reasonable to keep the fee tier at 0.3%.
Currently, there are POOL / USDC (1%), POOL / ETH (1%), and POOL / ETH (0.3%) pools deployed on Ethereum mainnet.
The 0.3% tier has the most TVL at $1.9k. I would recommend this pool.
Ranges
Due to some of the counterparty risks involved with Arrakis, I’m inclined to use Uniswap V3 positions without a liquidity management solution for the time being. In any event, we would need to determine how many positions we want and what the ideal ranges would be.
As we did in our Polygon experiment, I would recommend we establish three main ranges. We didn’t include an out-of-range position like we do below, but the Polygon experiment was a testrun ahead of putting together a formal proposal to execute on Ethereum mainnet. The goal is to learn from our previous experiences with POL experiments like Olympus and Ondo LaaS.
The ranges we propose for POL on Ethereum mainnet are as follows:
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TWAP protection range
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Concentrated in-range position
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Out-of-range diversification position (100% POOL above a certain price to a high price)
I’ll review the methodology and potential ranges for each below.
TWAP protection range | 0 to infinity
Should the community build liquidity with enough depth, Uniswap V3 could serve as a reliable TWAP oracle. Having an oracle for POOL would provide several benefits–namely, the potential to have POOL listed on a decentralized lending protocol. TWAP attacks should be mitigated by providing full range liquidity. While we may not be using the Uni v3 pool for this purpose now, we want to future proof our approach and create a pool that allows for greater POOL composability without the undue risk of a TWAP attack.
Having at least $5,000 in full-range liquidity would increase the cost of a TWAP attack signifcanlty; providing $10,000 in full-range liquidity would increase that cost to a degree where TWAP attacks become less likely. This liquidity would be similar to Uni v2 liquidity. It would always be in-range but it wouldn’t earn as many fees as a more concentrated position.
We can use Euler’s TWAP attack simulator tool to demonstrate the cost of an attack using two tokens as example use cases: MTA and IDLE.
The MTA / ETH (1%) pool has $290.95k in TVL. You can see below that liquidity is provided in a concentrated range with no full-range liquidity. This makes it easy to manipulate the price over the course of one or more blocks.
By simulating the cost of a TWAP attack over one or more blocks, we can see that the value gained from an attack is more than the cost to conduct the price manipulation. This means an attacker can move the market price of MTA if there is an arbitrage opportunity for them to do so. Given this, it’s unlikely this token could be listed on a decentralized lending protocol. It’s likely it could be listed on Euler, but it would never make it out of isolation mode.
Source: https://oracle.euler.finance/
Let’s evaluate another token: IDLE. The IDLE / ETH (0.3%) pool has $17.31k in TVL, but they have ample full-range liquidity. This means the cost to conduct a TWAP attack far outweighs any benefit for an attacker.
By simulating the cost of a TWAP attack over one or more blocks, we can see that the value gained from an attack is less than the cost of an attack. With just $17.31k in TVL and ample full-range liquidity, a TWAP attack becomes cost prohibitive.
Source: https://oracle.euler.finance/
Adding a TWAP range future proofs the position and allows us to explore other possibilities in the future should greater liquidity emerge on the Uni v3 position.
Concentrated in-range position | 0.0004 to 0.0012 ETH per POOL
This range will create depth in the active trading range, but we’ll still have enough ticks within the established range to move up and down in price. It’s unlikely that POOL would go out of this price range in the short-to-medium term.
We can look back to the POOL / ETH price, as sourced from CoinGecko, over the last year. POOL was last at 0.0012 ETH per POOL on 10 January 2022. The lowest price was .00036434 ETH per POOL on 18 June 2022.
A range set between 0.0004 to 0.0012 ETH per POOL allows enough range for POOL to move in price while staying in range, earning fees, and providing users with the ability to trade POOL <> TKNS.
If/when POOL increases in price beyond this range, then we’ll need to rebalance liquidity for our POL. The third range would help to diversify the treasury from POOL into ETH should POOL price increase out of this concentrated position.
Out-of-range diversification position | 0.001 to 0.01 ETH per POOL
As we’ve seen in the past, the DAO is bullish on POOL under all conditions and it’s unlikely that a vote to diversify would be executed at a future time to capture sufficient value for the treasury. Instead, we can set a range that moves from 100% POOL to ETH as the POOL token becomes more successful.
By putting POOL above the current trading range, the treasury would benefit when the market price increases, and we’d still be providing ample liquidity for POOLers who want to buy or sell. If the concentrated range moves out of the active trading range, then it would be 100% ETH that could be withdrawn and added to the treasury; used to increase in-range POL; or used to set a buy order for POOL underneath this range’s price bands—this is effectively a buyback range set below a certain value in ETH per POOL terms.
An out-of-range diversification position would allow us to diversify into ETH as POOL becomes more successful and buyback POOL should the price decrease below a certain price in ETH terms.
Which network should we build POL?
The prize pool network is across Ethereum, Polygon, Optimism, and Avalanche at the moment. Currently, there’s a small amount of POOL liquidity on Optimism in Velodrome; however, on-chain governance is not yet possible on networks other than Ethereum.
To date, the majority of all trading volume still occurs on Ethereum mainnet. Because PoolTogether’s on-chain governance is only on Ethereum at the moment, building POL on Ethereum is likely the best approach. How the POL strategy is implemented is 100% up to POOLers. Whichever network we begin to build POL on, we should consider the treasury’s current capital restraints and where we can effectively build POL where ample volume will occur.
Cross-chain network POL considerations
As we saw in our Polygon experiment, price movements between chains/networks results in arbitrage opportunities that MEV bots take advantage of. This means a bot will buy POOL for a lower price on one network, bridge POOL to another network (i.e., Polygon), and sell POOL for a higher ETH price. This rebalances pools across networks.
Greater TVL means the volume required to move prices will be much larger than it currently is. At scale, this issue should be negligible. If there is a major difference in TVL between Uni v3 POOL / ETH pools on different networks, then the arbitrage opportunity can extract more value from the treasury’s POL positions, as they are buying low on one network and selling high on another. This ultimately reduces the amount of (W)ETH in our positions.
It’s too early to formulate a cross-chain strategy, but when the community moves toward that discussion, there should be an effort to try and ensure some level of consistency across networks.
TWG recommendations
It’s clear that Uniswap V3 is the best option for the treasury. Allowing more users to trade POOL and get involved with governance will further help decentralize the protocol and allow active community members to increase their ownership in the protocol without incurring significant slippage. It will also dampen POOL volatility as we grow our position, which has a net benefit for the protocol’s financial health.
We would recommend the following amount of POOL and ETH per previously discussed ranges:
- TWAP protection range| 0 to infinity | 3 ETH + 3 ETH worth of POOL
- Concentrated in-range position | 0.0004 to 0.0012 ETH per POOL | 37 ETH + 37 ETH worth of POOL
- Out-of-range diversification position | 0.001 to 0.01 ETH per POOL | 62.47 ETH worth of POOL, which is ~108.7k POOL at the current price
The total value of these ranges together would be 142.47 ETH, with 80 ETH worth of in-range liquidity. This amount of TVL would allow for more efficient trading, which means larger trades and less slippage for POOLers.
Next Steps
The PoolTogether community can review Part 3 and share their comments regarding the TWG’s recommended methodology, ranges, and recommendations for the amount of POL to provide.
This post will be active for at least the next 6 days before transitioning to a PTIP.