New YFI Token Economic Model

YFI Token Economics

Michael Anderson, Framework Ventures
tg: @im_anderson

Purpose

There is currently a lack of clarity around two core components in the YFI token economic model: inflation and fees. As part of YIP 31, 50% of the YFI inflation will go to “LP Rewards” but does not disclose any of the details. The current fee model is based on a “dust” approach to collecting and redistributing, and it’s too hard to assess how sustainable that is into the future. Thus, we want to propose a token model that solves for both and builds a competitive advantage for YFI.

Background

Our long-term competitive advantage will be the effective use of highly valued YFI token inflation. We have already seen some and can assume that there will be more variants of YFI competitors seeking to opportunistically steal attention and market share. The advantages that YFI has now are it’s first-mover position, high-quality community, and engagement momentum which ultimately leads to a higher token value, for now. As stewards of this ecosystem, we need to adjust the token model to continue to build an advantage for YFI.

Our model constructed about under the following assumptions and perspectives:

  1. The current fees are assumed to be ~0 or not regularly occurring/automated
  2. YFI inflation should align specifically with long-term participation in and proliferation of the whole ecosystem
  3. The fee pool should flow back to active YFI participation
  4. The overall design assumes perfect competition with any YFI variants on yEarn Strategies (parasitic vaults - no defensibility with high performing strategies as they can be replicated)

Proposal

Governance:

An informed and active community is the lifeblood of any successful blockchain ecosystem. YFI holders and stakers are able to vote with their tokens on all parameter changes in the system, on proposing new ideas, and on implementation of new proposals (as defined in YIPs 10 and 12). YFI holders should want to be governance participants, but we should incentivize long-term and consistent participation in the governance process.

Voting with YFI can only occur with staked YFI in the governance contract, as is currently the case in V2. We propose 60% of YFI LP inflation that will be used to distribute to governance stakers, accruing more YFI the longer the YFI is staked in the contract. Stakers must have voted in one of the last three quorum-reaching proposals to unstake YFI and to redeem their YFI rewards (there will at least be a “check-in” vote once per month to provide a participation opportunity if no other proposals come up for a vote).

TBD:

  • % YFI inflation to a gov rewards pool (i.e. 60% of the inflation going to “LP rewards”)
  • Method of determining “active” participation in governance

Liquidity Providing:

Liquidity providers in yVaults will provide assets (e.g. USDC) to be used productively by the systems’ Strategies, earning a return in the form of that yVault’s asset upon exiting. To provide proper accounting, each yVault has its own LP token (e.g yUSDC) which is minted and burned at entrance and exit from the pool. To further incentivize pool participation, the staking of LP tokens will accrue YFI rewards. Similar to the governance streaming rewards, the longer the LP tokens are staked in the contract the more YFI tokens are earned.

While yVault LPs will be earning high APRs based on the different Strategies using the Vault’s assets, we believe that these users should be participating in the YFI governance process as well. We propose distributing 40% of YFI LP inflation to LPs who stake their LP tokens. We also believe that all Strategies are ultimately not defensible from free riders in the long run. As such, we need to ensure that YFI inflation for LP stakers is a strong incentive for discerning collateral providers to choose YFI over competitive variants.

Initially, the types of LP tokens that will receive staking rewards are the yVault LP tokens generated from participation in each Vault. Eventually staking rewards could go to Balancer pools or new platforms that don’t exist yet. Governance voting would enact these changes.

As an LP provider and staker of LP tokens, here is the additional yield that can be earned from YFI inflation in excess of the Vaults’ APR, based on TVL and YFI price:

TBD:

  • % YFI inflation to a gov rewards pool (i.e. 40% of the inflation going to “LP rewards”)
  • Method of adding, removing or adjusting distribution to LP staking pools

Cash flows:

In the long run, the YFI token’s value will be determined by its ability to capture sustainable cash flows from the platform. Implementing a recurring “management fee” on the yVault users based on their participation will leave a strategic hole open for YFI competitors to undercut leveraging the same Strategies available on yEarn. Instead we should incentivize long-term participation in the yVaults by adding fees when entering and exiting the vaults, advantaging consistent participation.

Model 1- Ultimately, we will need a sustainable fee model to drive YFI value. We propose implementing a 0.2% entrance fee and a 0.3% exit fee for all of the yVaults. The fees (denominated in the Vault’s token) will be used to purchase YFI on the open market (i.e. 1inch) and then added to the governance staking rewards pool and distributed to all current stakers of YFI tokens as a streamed reward. We call this model a “buy and pool”.

We have limited data, but from ~6 days of yUSDC activity we can assume a 3-4x velocity per week of LP tokens (~$20M volume in 6 days = $50K fee potential or ~$2.5M annualized).

Model 2 - Ultimately, we will need a sustainable fee model to drive YFI value. We propose implementing a fee upon unstaking either governance or LP tokens from their respective staking contracts. This fee could be modeled using a decay function using tenure in the pool (higher with shorter time in pool and lower over time) leading to the ability for no fees after some time.

Using a basic example, we could use the function Y = -(0.02/12)x + 0.02 where the x axis is months in the pool and y axis is the fee %. This example features a 2% fee at the start of the pool, which decreases linearly over 12 months. The purpose here is to incentivize long term participation in the pool. Any YFI fees collected would go back to the governance staking contract pooled incentive as an additional reward with the inflation.

Furthermore, if the other fees are deemed to be sustainable in a competitive market, we suggest also using the buy and pool model for distributing them back to governance stakers using YFI purchases on the open market.

TBD:

  • % fees for enter and exit
  • New fee sources added to “buy and pool” model
34 Likes

Very interesting proposal. I especially like the feedback loop this creates to continually replenish the governance / rewards pool. (?)

Need time to digest this but I like it.

Are you saying that yEarn would not take a fee to implement its services and instead have entry and exit fees? Not sure that’s so great. Perhaps a variable fee based predetermined deposit terms? Much like term deposits are today?

4 Likes

Incredibly thoughtful post. Agree, sustainable fee model must be discussed/prioritized. Participation must be incentivized for the long haul. Thanks for sharing the insight from the short lived yUSDC numbers. Model 1 such an interesting place to start.

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Model 1 should not be used, as it encourages upfront costs across DeFi.
Charging upfront costs in DeFi is not a custom and should never be. If yEarn is expected to set the standard, we should expect everyone to follow and also implement it (Granted Aave has a small upfront BORROW fee), completely hamming whatever DeFi was and is.

I believe yEarn should only charge postive fees, these are limited to fees on earned volume,
Charging what can be called negative fees: Upfront costs, duration costs or other fees that could potentially bring an investment in negative, should be avoided.

And regarding sustainability, is a velocity fee really sustainable in a financial investment market? In the future, no sudden extreme liquidity mining scheme should provide crazy returns. Instead the returns will be mostly arbitraged to a fixed % across investment profiles.
This means, that the velocity will generally be very small. Also ask yourself, how high velocity does the indexes in traditional finance provide?

8 Likes

This is definitely the key issue here. How can we capture the value that’s being generated by the platform? How can we do it in a sustainable way?

Some comments regarding this:

  1. I agree that management fees is not a strategic way to capture value in the long run.
  2. However, I think the same argument used to oppose management fees applies to entering/exiting fees: Any competitor could easily offer lower fees.
  3. Are entry fees necessary? To me, they feel like a point of friction when first interacting with the platform. Would it be better to do only a 0.5% exit fee?

Even though I don’t think either the management fee nor the entry/exit fee model offer a sustainable cash flow generating strategy in the long run, I also think we’re not going to find the perfect strategy at this stage of the ecosystem. To find that optimal strategy (if that is even possible?), I think we should begin trying different models to see how they work in the wild and based on that experience, iterate. For this reason, I support this proposal: As a first step upon finding a cash flow generating model that works long term.


One last thing to think about: Would it be possible in the future to generate non-replicable strategies (strategies with a moat)? How could we leverage AUM to generate strategies with a moat (are there opportunities that get better the larger the capital pool)?

1 Like

This does not address all the issues, but with increasing volume we could gradually decrease the fees (similar to a volume discount). That said, with yields in the double digits and fees uner 1/2 percent, a slight reductuon in fees may not be meaningful – and a competitor can always offer lower fees.

Great thoughts! Details were actually left out of YIP-31 purposefully, so moving the conversation forward is much appreciated.

  • Paying out 60% to governance feels aggressive, what is the thinking behind this?
  • How is the 40% to yVault LP stakers specifically proposed to be split? Based on value of the LP token staked proportional to total value of LP tokens staked? Is there a cap of what can be earned per vault per week, out of the total weekly LP allocation? Please really spell this out.
  • Given comments on entry fee, a no-entry, larger-exit fee may reduce friction and be more generative.
  • What other product(s) do you see as low hanging fruit for introducing fees and incentivizing? yswap?
3 Likes

If we are planning on incentivizing LPs with 40% of YFI inflation, then wouldn’t that more than compensate for any fees that we may charge for mgmt/exits?

variable fees based on deposits are the “management fees” that would leave the platform open to undercutting. I agree that entry fees are not as powerful as exit fees and were included more as a strawman.

“One last thing to think about: Would it be possible in the future to generate non-replicable strategies (strategies with a moat)? How could we leverage AUM to generate strategies with a moat (are there opportunities that get better the larger the capital pool)?”

This is very hard to do, if not impossible when everything is on-chain.

1 Like

Good write-up.

  1. Not a huge fan of entering fees as others have mentioned (friction on getting assets), but exit fees are fine
  2. I actually like a recurring AUM fee, even if small. If what yEarn charges gets undercut by a competitor, we can always reassess when that arises. While users will shop for lowest fees, it’s not the only determining factor. Once we onboard assets and people are comfortable with the protocol, assets should be stickier over time. I’m not convinced that everyone will pull their assets out of yEarn for a small fee undercut. You see this a lot in trad finance where people are lazy and use what’s comfortable. Granted, switching costs are a lot lower in DeFi, so premium over competitor can’t be as large.
    *EDIT - the benefit of an AUM fee over enter fee is that users don’t really see it. If you’re charged 0.2% on deposit, you’ve already seen your balance decline on your first interaction with the protocol. A fee on interest earned is more hidden.
  3. I like the buy & pool model as it keeps YFI holders earning YFI -> longer-term alignment, easier for tax purposes, etc.
3 Likes

I agree with the comments, an exit-only fee is favorable to an entry fee and an exit fee. But the first point is to build consensus around the need for a fee model to derive YFI value.

On the inflation allocations, the amount going to LPs should remain lower than 50% to incentivize LP rewards earners to move to the governance staking (>50% of YFI inflation + fee pool) vs. selling YFI once they receive it. All of this is subject to governance and adjustments with more data from a live version.

All in all, the parameters can all be adjusted, the purpose of this is to propose a new model. Any pushback on the concepts of fee capture and governance staking?

4 Likes

Can they undercut if we are adding to yield from 40% of the YFI rewards? I think theoretically a competitor could but that would mean that they would have to meet/exceed the value of our inflation rewards (which might be hard to do considering the price of YFI). Please correct me if I am wrong.

I was actually hoping for a higher percentage of the YFI rewards to go to YFI stakers. But I understand the rationale

This sounds good. I was saying in a different thread any sort of burning is dumb. We should buy back YFI on open market + pool it and get yield of course.

Also governance needs to be high. I plan to be a “rational” YFI staker (or LP). What that means to me is if I have to invest many hours of time/due diligence to read and understand proposals so I can vote intelligently I would like to be compensated. If the compensation is not there, I’ll just LP or go for the highest yield and hope there are those who steward the conversation and are more altruistic than me. I don’t think this is unreasonable and we should reflect that that is likely the case for most people here and ensure we create systems that make me actually want to really care about it beyond altruism. I agree with your analysis on gov and think the key is actually having (good) incentives ($) in place there for participation and conversation

2 Likes

Also in a perfect programmable world. The best balance between .2% upfront fee and .5% exit fee is say I deposit $100 worth of assets into the system. Rather than it showing me 99.8 right away, from a programmable perspective (I’m not sure this is possible) the best would be the first .2% of the (…yes I know it would be a trace less than .2% but just follow this thought for simplicity) revenue generated on that capital would go to the protocol and then from that point onwards it would just have the same AUM fees/exit fees as whatever we described.

It’s the same as a .2% upfront fee, but from a consumer/psychology perspective you put $100 capital in, and rather than it dipping below <$100… you only see it go up. It would just take a little bit longer of course to first harvest that .2% and then it would tick up on the rate. Psychology like this matters so much more than people think, it really does, and if there isn’t a bunch of complexity I think this is something we should consider. It also gives us more upfront cash flow, which is great ofc

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But I will say that overall I agree with OP. This is well thought out model. I think we can start out with most of these thoughts and adjust if necessary.

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This is a fantastic proposal that I believe substantively addresses the most important issues at hand - namely encouraging and rewarding long-term participation in the ecosystem and using YFI and Y Suite products to virtuously provide value to one another.
I agree with most of the critiques as well and believe the details will have to be ironed out.

When we start to lock in ideas down the road, I wonder if we should use some multisig funds to hire a consultant, like the folks at Gauntlet, to provide feedback on our models and run simulations of this stuff. We have a 100x dev who is currently running circles around competitive forks, but we’re also going to need 100x governance and incentives structures to give the y ecosystem the highest strength, value, safety, and longevity possible. To my mind, the more rigorously we can model and test our designs, the better, especially considering the fact that the complexity of this system could grow quite large as Andre releases more products.

I’m Very Much a lurker/outsider in this space, so I’m not even sure if that is the intended use case for this type of service! But if so, maybe that’s an idea? Regardless, to my relatively dullard mind, most of the smartest people in this space are already building out this governance process, and I really like the direction of this proposal in particular.

2 Likes

What we need is a serious data scientist to help analyze the data when we start these programs.

Thank you Mike. A good proposal, our preliminary thoughts so far:

  • YFI inflation can come in staked form, thereby “forcing” participation. Could introduce immediate vest but have a say 10-20% penalty whereby such penalty goes to all YFI stakers.

  • No strong view on the 60/40 split of inflation as of now. May want to consider inflation to top strategy providers as well to keep them within the ecosystem.

  • We think positive incentives works better than “penalties”, and inflationary taxes work better than one-off taxes. In that sense, we feel like 0 entrance / exit fee, but an increasing flow-through of YFI reward upon longer stake time, a cascading decreasing management fee + performance fee (of which benchmark is base rate of out-right lending on COMP / Aave, for example, or a hurdle rate) on AUM may be better in incentivizing a larger LP pool.

  • Similar to Millennium and Citadels of the world, these platforms offer best-in-class back offices for all the data, quants, risk assessment, etc at a fee to pod managers. Given the sophisticated user base of both YFI stakers, strategy providers, and LPs alike, some form of bundling of subscription towards the likes of Delphi, Nansen, etc for ecosystem users (or even stakers) could be interesting.

  • We generally like accruing inflation to YFI stakers. May also consider siphoning rewards to top strategy providers.

14 Likes