STFX has utilized a protocol-owned liquidity (POL) structure since TGE. Reasons for this are simple: there is well-documented evidence over the past 3 years that renting liquidity from mercenary capital is long-term destructive to protocol health. When emissions run dry, capital evaporates and the protocol lacks a tangible solution to addressing the liquidity problem going forward. Additionally, the continuous sell pressure of harvested rewards by LPs contributes negatively to the token price, which dilutes long-term holders. By enacting a POL model, protocol DAOs can capture Uniswap trading fees, avoid paying expensive LP rates to misaligned actors, and better insulate themselves from token hyperinflation than a traditional liquidity mining reward-based system.
In a traditional non-POL-based system, independent actors provide liquidity to the Uniswap pool based on their unique risk/reward profile. Thus, the market (which by definition is the collective set of independent participants) effectively establishes the TVL of the system, and dynamically equilibrates as LPs add/subtract liquidity in response to profitability, volatility, trading volumes etc.
Parameterizing a POL system is trickier since the protocol is the sole LP within the pool. It does not have the same market equilibrating forces that a traditional pool would, given the lack of competition. POLs can be contextualized somewhat as a public good since they aren’t necessarily profit-driven structures, and operate as a broad-stroke solution to address fundamental issues exposed by open liquidity pools. As such, they necessitate active management to respond to current market dynamics; what made sense in the past may not make sense in the future. While some teams have attempted to automate their POLs, deriving a single algorithm to account for a wide array of variables is incredibly difficult. We believe the more optimal solution is to manage the STFX POL structure via community governance.
In response to the team and community feedback, the initial POL structure was optimized around extremely deep liquidity. This made sense in the early stage of the project: macroeconomic conditions were quite volatile (both crypto and risk assets in general), and STFX notional trading volumes were high with many tokens changing hands after the initial speculation phase of the sale. 5 months later, daily trading volumes have subsided considerably, and the turnover of coins amongst wallets has drastically decreased. The process of coins transferring from speculative, short-term hands to long-term holders is well underway. One entity, in particular, had accumulated roughly 25-33% of STFX circulating supply immediately following TGE. This actor recently market sold their position, almost singlehandedly contributing to the negative price impact we’ve witnessed over the last week.
We propose a pro rata 25% reduction to both Ethereum and Arbitrum STFX/ETH Uniswap pools given the state of the network, current trading volumes, and the recent derisking of some large-scale speculators. Running some very basic comparables, it is quite apparent that the STFX POL structure is considerably over-capitalized compared to projects of similar scope. While this depth of liquidity has been helpful in absorbing supply pressure up to this point, we question the efficacy of the program going forward, given the fundamental shift in variables and conditions. Continuing this depth of liquidity not only sets an inherent price ceiling on purchases but also incentivizes well-capitalized actors to come in and manipulate price action in the short run, given the low float/market cap and ability to exit conveniently. This induces a lot of volatility for the token and is counterintuitive to the long-term-orientated holder STFX is trying to attract.