What is Liquidity-as-a-Service (Laa$)?
In November 2021, Fei Protocol and Ondo Finance launched the Liquidity-as-a-Service (Laa$) offering as an alternative to traditional liquidity mining. Laa$ enables projects issuing tokens to increase their liquidity on a decentralized exchange in a capital efficient way.
The total deployed to the program is $100M, $50M comes from the projects and this is matched with $50M from Fei. The first vaults are: Universal Market Access (UMA), Gro Protocol (GRO), ShapeShift (FOX), NEAR (NEAR), Synapse (SYN) and Kylin Network (KYL). It is amazing to see that this service found product market fit very quickly and is gaining traction within DAOs.
Why Laa$ is useful?
Traditional Liquidity Mining attracts temporary capital at a high cost, diluting current token holders and increasing sell pressure on the token. Laa$ is a cheaper alternative, where projects can get immediate liquidity without issuing more tokens and dealing with upfront capital costs. To summarize, Laa$ has the following benefits:
Cheaper and save the Treasury: The project earns trading fees which reduce the cost from impermanent loss and the fixed interest rate. Sometimes, the project can also earn rewards (e.g. Fei Protocol is currently incentivizing partners with TRIBE). In liquidity mining there is the need to spend a great amount of the project token and in most scenarios the cost is higher than LaaS. As I am going to show in the next section, there is a huge value in saving the project’s Treasury from unnecessary expenses.
No upfront cost: there is no upfront cost as the project just needs to pay a small fee of 5% APY at the end of the period (2-3 months).
Less risk of manipulation and more oracle resistance: more liquidity increases the oracle resistance against price manipulation. This is crucial, for example, for the DAOs that want to create a Fuse pool.
Increase project adoption: with low liquidity, users have difficulties to acquire the project’s token. To grow and increase adoption, projects need liquidity depth to attract new users and stakeholders to enter through the market.
Higher chance of getting listed by centralized exchanges: exchanges have liquidity requirements to add new tokens to their platforms.
How does Laa$ work?
The project deposits its native token into an Ondo vault with a specific duration and Fei Protocol doubles those deposits with FEI. The amount in an Ondo Vault is used to provide liquidity on Uniswap or Sushiswap.
The vault consists of two tranches. The project assumes the variable tranche and Fei Protocol assumes the fixed tranche.
At the end of the period, Fei Protocol receives the supplied FEI plus a fixed rate of 5% APY and the project receives the remaining value.
The cost to the project is:
Fixed Interest Rate + Impermanent Loss – Trading Fees – Rewards
As the project is providing liquidity on a DEX, the total cost is also influenced by impermanent loss and the trading fees earned on the pool. Depending on the volume traded and on the token price variation, the cost can be reduced and can even become a revenue to the project.
In practice, the project is borrowing money from Fei at a low cost (currently 5% APY) to increase its token liquidity. This is the debt market emerging for DAOs.
The liquidity mining strategies are similar to using equity to attract liquidity. Considering the temporary effect of liquidity mining, it is less efficient than Laa$.
If the price of the project's token appreciates vs FEI (which is a stable asset), it would have extra FEI. However, in a downside scenario, the project would then need to sell some of the additional tokens in the LP for FEI, or find a way to make the fixed tranche whole.
The best way to learn is through an example.
In the table below, we can see some possible scenarios of the project variable tranches return in relation to the project’s token value. In other words, this compares with the alternative of just holding the token and not spending it. This is not a reasonable assumption, as the project will need to spend something to increase its token liquidity.
Even in this comparison, Laa$ can be better than just holding the tokens in many scenarios between -30% and +30% of token price variation.
Source: https://docs.google.com/spreadsheets/d/186A3W4aqPT5u7vKeCerEP72H5_-w0eCSNC7xjIIJ8Lg/edit?usp=sharing
A better comparison is the one with the cost from Liquidity Mining, an alternative method to increase the token liquidity.
Let’s say project X is analyzing alternatives. In order to attract $10M in liquidity, we assume a required APY around 60%, something between $6M per year, or $1.5 M for 90 days in liquidity mining rewards. This is the cost for this alternative.
To calculate the cost for Laa$, let's consider that the project is receiving 8% from trading fees.
It is important to highlight that in all scenarios the LaaS alternative would be superior to Liquidity Mining, except in cases of a huge drop in token price.
Source: https://docs.google.com/spreadsheets/d/186A3W4aqPT5u7vKeCerEP72H5_-w0eCSNC7xjIIJ8Lg/edit?usp=sharing
When the price of the token goes up, Laa$ is a much better alternative for the project, because they keep the tokens that now have more value.
Laa$ is a capital efficient debt that helps DAOs to avoid unnecessary dilution of token holders
In those scenarios, the project can have revenue instead of a cost. For example, if the token increased 60%, the project will have a positive return of $ 2.7 M at the same time it is providing liquidity to its token.
The higher APY the project needs to pay to attract liquidity the greater is the benefit of Laa$. Newer projects tend to pay very high APYs to compensate for the additional risk. For these projects, Laa$ is even more compelling.
I hope this article can help DAOs in the challenge of bootstrapping their tokens liquidity without giving up their Treasury.
P.S.: Thanks for the comments from Brianna Montgomery, Gabriel Bianconi, Arcology and DioDionysos.
Please note that this letter is not intended as financial advice.