Liquidity and Rewards
Last updated
Last updated
The last chapters described the process for bringing forward contracts on-chain and exchanging them for liquid tokens compatible with decentralized/centralized exchanges (i.e., following the ERC-20 standard). This section describes the process through which Solid World integrates and incentivizes third-party mechanisms that facilitate the exchange of Collateralized Batch Tokens.
Solid World's primary launch mission is creating a profoundly liquid forward carbon market, which can facilitate the further growth of the voluntary carbon market. Based on historical experience, DEX liquidity has been highly adequate at bootstrapping an entirely new market. To achieve this most efficiently, we rely on the invention of "concentrated liquidity," as implemented by Uniswap Labs in their Uniswap V3 decentralized exchange protocol (DEX).
An Automated Market Maker (AMM) is a mechanism that allows for the automatic exchange of two or more assets within a "liquidity pool" based on some equation. These assets are provided to the liquidity pool by the users of the AMM, known as Liquidity Providers (LPs). They seek to benefit from the fees generated by the exchange's activity and any incentives provided for doing so.
Concentrated liquidity builds on the concept of a Constant Function Market Maker (CFMM), a form of AMM. Constant Function Market Makers use a simple function for deciding the exchange rates between two assets:
Where x is the amount of asset A within the pool, y is the amount of asset B in the pool, and k is a constant. The equation functionally assumes that the two piles of assets within the liquidity pool (pile of asset A and pile of asset B) are equally valuable and price the exchange rates accordingly. If this is not the case, it opens up the market to arbitrage that value by trading the over-valued asset for the undervalued asset and cashing in the spread. We suggest watching Whiteboard Crypto's explanation on the topic for a detailed walk-through of how the exchanges happen.
The challenge with CFMMs is that they are capital inefficient, as they will remain liquid for all possible exchange rates. If asset A becomes 1000x more valuable than asset B - the CFMM will continue functioning as usual. While this would be desirable for assets that regularly see such drastic shifts - such as most cryptocurrencies - this approach does not use the liquidity provider's liquidity appropriately if the underlying assets are more stable. For example, if you were to provide USDC/USDT liquidity on a CFMM such as Uniswap V2, the balances of USDC to USDT would not significantly shift within the position. However, the price impact of smaller transactions would be substantial enough to make the offered exchanges unattractive.
Concentrated liquidity solves this problem by providing Liquidity Providers the option to define a price range in which liquidity is deployed. This means that instead of facilitating any exchange rate of two assets (and therefore retaining liquidity all along a price curve), concentrated liquidity enables trades at significantly better exchange rates and lesser price impacts within a narrower range, becoming illiquid if the exchange rates leave the price range specified. To illustrate this, we have included illustrations from Uniswap V3's whitepaper.
This approach is preferable for assets where the volatility is less extreme. Carbon credits and other environmental assets are likely to fall into this category. In addition, by utilizing concentrated liquidity, the Protocol can incentivize liquidity depth equivalent to more than 3x that of deploying the same capital within Uniswap V2.
Solid World's Protocol is integrated with Gamma Finance's non-custodial solution for managing concentrated liquidity positions on Uniswap V3, known as the Hypervisor. Hypervisor's code has been fully audited by Consensys Diligence and can not be upgraded, minimizing the possible attack surfaces. Additionally, Solid World holds the private keys for enacting any changes to the liquidity positions (i.e., changing price ranges at which liquidity is deployed or the ability to pause trading in case of emergencies).
Gamma Finance, in turn, deploys the liquidity in Uniswap V3, the most thoroughly battle-tested DEX in existence. As a result, among other metrics, Uniswap V3 has the highest TVL (total value locked) and the highest daily volumes of any decentralized exchange.
As it has been shown repeatedly, the opportunity to provide liquidity is not sufficient to attract or retain liquidity providers over time. Therefore, as Solid World's Protocol benefits from the deep liquidity existing (as this makes the Protocol attractive for participants), it shares these benefits with its LPs through rewards in a symbiotic relationship.
Solid World's rewards contracts are based on Aave V3's peripheral rewards contract, as the design allows various rewards schemes to incentivize a single asset. For example, this mechanism pays rewards in USDC, governance tokens, and newly minted collateralized basket tokens (as described in the previous chapter) for Liquidity Providers who stake their liquidity with the Protocol.
