Applying value flow to an AMM

Following on from my earlier post titled “rethinking tokenomics”, I want to look at how an AMM DeFi project might create value flow back to token holders while bringing sustainable financial benefit to LP’s and the project treasury.

I have experience building and bringing AMM’s to market and I’ve been struck how even very popular AMM’s struggle to bring value to these crucial areas. There can often be a belief that the best technology combined with liquidity and volume grow will result in token value and market cap growth but as we’ve already established, that is rarely the case in practice.

So in the post I pose the following question.

“If I was to design a tokenomics model for an AMM today, what might it look like?”

To begin with I will list out what I want to see from this new model.

1. Revenue to the projects treasury. The project should ideally have a 10 year runway which will allow it to grow and expand in both bull and bear markets. To maintain that runway the project needs revenue to the treasury.
2. It should reward the projects token holders. It should make token holders want to buy and hold their project tokens long term.
3. It should create upward forces on token prices.

Tokenomics applied

To begin with I would mint all the tokens that will ever exist on day one to mitigate the problem of future inflation. Inflation is such a problem for projects that I believe that inflation should always be the forced to be as low as practical for the project. So lets start with an arbitrary number, 100 million ABC tokens.

These tokens would then be distributed to where they need to be to seed the project launch. The following figures are examples and would change on a project by project basis.

25% of token sold to raise capital in the treasury

25% given to the project DAO treasury to manage

25% given to the team and founders

25% placed into a reward pot.

For the first year, the 25% in the reward pot would be given away as rewards to LP’s in pools containing the ABC token. LP’s are used to receiving rewards and so for the first year we will transfer rewards to LPs without minting any new tokens. This means there’s a token transfer to the market but not inflation from new tokens.

For revenue we will add a base protocol fee on all transactions. In this example we’ll set it as 1/3 of all swap fees are sent to a protocol fees wallet. LP’s would accept that 1/3 of fees are retained by the platform in exchange for a better funded and supported platform and other benefits discussed below. Note that this means fees are being collected in a mix of tokens including stables and high value tokens such as WETH.

Each month, this protocol fees wallet is distributed along the following lines.

1/3 goes to the treasury as revenue.

1/3 is paid out as rewards to LP’s in ABC pools. This provides a passive income in a mix of tokens to ABC token holders who have their ABC staked on the AMM platform.

1/3 is used to buy back ABC tokens on the open market. Those tokens are burned to reduce overall supply of ABC tokens in the market.

The above example is very different to most tokenomics models today but introduces some interesting forces to the platform economy.

1. A gradual shrinking supply of tokens leading to a deflationary effect on the market. Deflation results in a positive force being applied to the token price.
2. Token holders earn rewards for the first year but even after that, there is a strong incentive to continue to hold and stake tokens since that ensures a continued passive income from fees in all pools. Since tokens are frequently being bought and burned then these fee rewards to each ABC token concentrates over time, increasing reward payouts over time to each ABC token. This also creates a positive price force on the token.
3. The DAO and team benefit in exactly the same way from other token holders and so are equally incentivised to hold and stake tokens.

Overall the tokens in the market become more scarce, more revenue generating and more valuable over time, for as long as the project is able to maintain liquidity and volume. This is a direct link between performance and token price. Crucially, not only to token holders increase earning potential over time, the project is revenue generating and better positioned to succeed and expand even in bear markets.

The above is a theoretical model and just one way how we can rethink tokenomics by focusing on value flow or utility and how that can support projects long term.