Preface

The concept of Liquidity-as-a-Service (Laas) was proposed by Messari in Oct 2021. The need for the service arises when a large number of protocols don’t have enough liquidity, leading to a lack of support for the prices of the protocol tokens and thus token price tanks. This erodes user confidence in the protocols and generates a phenomenon known as “Death Spiral.”

Following the invention of liquidity mining by Compound in 2020, the market entered the DeFi Summer period, during which a large number of protocols adopted liquidity mining to kick-start their operations, and attracted users through large amounts of mining subsidies. However, as more and more protocols introduced liquidity mining, low APY subsidies were no longer enough to attract capital and users to provide liquidity to the protocols. So, in order to compete for users, protocols rather bear higher costs to offer high APY to attract users at the onset of their projects. Yet, such a high APY is unsustainable.

Pure liquidity mining is no longer the best choice for projects to cold-start as both high costs and lower returns are unfavorable for the projects. Therefore, current DeFi protocols are faced with the challenges of how to attract sustainable liquidity in a sustainable way. Since Sep 2021, the market has gradually seen the emergence of protocols that provide sustainable liquidity services. And Tokemak is one of them. The article will elaborate on the operational mechanism of Tokemak products, including the current operating version (v1) and the upcoming version (v2); it will also analyze the current development status of the project.

Introduction of Tokemak

The predecessor of Tokemak protocol is Fractal, with the product launched in April 2021, and version 2 is about to be released. Up to now, the project has completed one round of financing and one round of public fund-raising, including $4 million in seed funding led by Framework Ventures; and $24 million raised in the Degenesis event’s token public offering.

The product and business logic of Tokemak is straightforward, achieving the goal of providing liquidity to projects by utilizing LP to furnish funds and LD to guide liquidity. This method embodied a certain level of innovation. In Tokemak’s operational mechanism version 1, protocols requiring liquidity provision are selected through a zero-cycle event (the mechanism for selecting projects in Tokemak). After a project is selected, reactors are created for the chosen projects. Subsequently, through two roles, the liquidity provider and liquidity directors complete the voting guidance, and the Tokemak protocol will distribute the users’ assets to different DEX according to the voting results.

The team announced in May 2023 that V2 is about to be released, introducing the concept of Liquidity Management Pools (LMP) which is mainly to optimize the system development of liquidity providers and DAOs. V2 includes two independent products - one is a dynamic pool allocator that can optimize LP returns between different pools and DEXs (Autopilot), and the other is a liquidity order book that allows DAOs to lease liquidity based on the transparent market rates (DAO Liquidity Market). Tokemak V2 will launch in sequence, with Autopilot being the first product, followed by the launch of the DAO Liquidity Market.

Image Source: https://www.figma.com/proto/XXveJKkpeZSBpKwCY1yKWD/Diagrams-and-Explainers?page-id=308%3A144&type=design&node-id=310-3938&viewport=895%2C546%2C0.04&scaling=scale-down-width&starting-point-node-id=310%3A2153

V1 Product Mechanism

In v1, the code of the protocol consists of three components: The project launch mechanism (also known as the zero-cycle event), the operational and rewarding mechanism for the two roles in Tokemak - LD and LP, and the mechanism for bearing the impermanent loss in providing liquidity.

Zero-Cycle Event

There are three phases of the Zero-Cycle Event: Degenesis、Genesis pool mining initiation, and Reactor event, among which the Reactor event is the core.

In order to have sufficient ETH and USDC to provide liquidity for projects later on, Tokemak established a Protocol Controlled Assets (PCA) reserve through the Degenesis event in July 2021. The Degenesis event is essentially similar to public fundraising, using its own TOKE tokens to exchange for users’ ETH or USDC. This event raised a total of $24 million as the initial liquidity reserve fund for the protocol. After the completion of the DeGensis event, Tokemak commenced Genesis pool mining. The following image illustrates the mining fund pool.

Image Source: https://app.tokemak.xyz/

The Reactor event is the core of the entire series. TOKE holders are required to vote for the top five projects that need liquidity provision within a week after the start of the Reactor event, establishing reactors for these five projects. The voting rules are: each custodied TOKE (not unlocked by VC) gets one vote, each staked TOKE (tTOKE) gets 4 votes, and each Sushi/Uni LP token holder gets 69 votes per LP token.

LP and LD Rewarding Mechanism

In Tokemak, there are two main roles. The first role is the Liquidity Provider, who can earn TOKE rewards by depositing single-sided assets into a Reactor or the Genesis pool within the Tokemak protocol. The second role is the Liquidity Director, who can determine how the assets in the reactor are paired with the assets in the Genesis pool through voting, as well as decide the exchanges to which these liquidity pairs are directed while also earning TOKE token rewards. Therefore, in Tokemak, essentially both LP and LD serve the reactor, which can be seen as an asset pool for protocols requiring liquidity provision.

In Tokemak v1, LPs deposit respective single-sided assets (such as Sushi) of the left side of the reactor and in return, receive corresponding tAsset (such as tSushi). Upon asset redemption, tAssets can be redeemed at a 1:1 ratio for the deposited assets along with corresponding TOKE rewards, without worrying about impermanent loss. Moreover, LPs can also deposit ETH and USDC into the Genesis pool. The assets deposited here, together with the ETH and USDC acquired during the Degenesis event, are utilized by LDs as the right-side assets in the reactor for the liquidity pairing process. For LPs, their earnings are calculated on a cyclical basis.

In the operating mechanism of Tokemak v1, only those who stake TOKE tokens can become LDs. For each TOKE staked, one obtains a TOKE voting right after the reactor goes live. Voting on the reactor can earn TOKE staking rewards (voting on the reactor is equivalent to staking TOKE in the reactor), and the more votes a reactor receives, the more liquidity it can be allocated. Essentially LDs use the voting rights of TOKE tokens to determine the allocation of ETH and USDC within the Tokemak protocol, that is, to decide on the distribution of available liquidity in Tokemak.

Image source: https://app.tokemak.xyz/

At the same time, protocols that have launched reactors also hold a large amount of TOKE tokens in the hands of their teams due to DAO to DAO cooperation. They can also obtain voting rights by staking TOKE, and guide liquidity to their own protocols.

Impermanent Loss Mitigation Mechanism

In Tokemak v1, the role of LP doesn’t need to bear impermanent loss. However, when Tokemak deploys LP’s assets to major DEXs, LP’s assets are inherently subject to impermanent loss. To mitigate that, Tokemak setup four measures to shift LP’s impermanent loss. This transfers the risk of impermanent loss to the Tokemak protocol itself and the stakers of TOKE tokens. The specifics are as follows:

1. When Reactor A’s assets suffer impermanent loss after deploying liquidity, it is first borned by the reserves of the reactor.
2. If the reserves are exhausted, the transaction fees and token rewards obtained from deploying liquidity in all reactors are used for bearing the loss.
3. If the reserves and income are both insufficient, the TOKE staked in the reactor will bear the loss.
4. If all three types of assets mentioned above are not sufficient, then it will ultimately be borne by the ETH and USDC reserves in Tokemak.

Although LPs in Tokemak do not have to bear impermanent loss, at the same time, it cannot obtain transaction fees and other token income brought by providing liquidity. The returns LPs can get are realized by TOKE tokens.

Pros and Cons of the Mechanism

• Overall, the product design has a certain level of innovation, with LP providing funds and LD guiding liquidity. The logic makes sense and the design is straightforward.
• Assisting projects with liquidity is inherently risky for the protocol itself. If the selected projects are not of high quality, the pressure of the decline of the coin price will be borne by the Tokemak protocol and the TOKE stakers, so this business model seriously tests the ability of the Tokemak team to select quality projects and establish cooperation with other projects.
• Tokemak actively bears impermanent loss to attract LP’s liquidity, but this impermanent loss will bring a certain asset loss risk to TOKE stakers, which is somewhat unfavorable to TOKE stakers.
• Tokenmak attracts LP’s liquidity and encourages LP to actively guide liquidity through the provision of TOKE token rewards. However, if TOKE price tanks, it can negatively affect the return rate and confidence of LP and LD. Without economic incentives, LP and LD will not be drawn to the TOKE protocol. As a result, TOKE may not operate normally or continue to assist other protocols with liquidity provision.

V2 Product Mechanism

The core of version 2 is still to provide liquidity for DAOs, and provides Liquidity Management Pool (LMP) for LPs and DAOs. The first product to launch in V2 will be Autopilot, which is centered around LPs. It can automatically rebalance multiple assets in the liquidity management pool, liquidity pool, and DEX. And the dynamic allocation mechanism based on liquidity and return rate can optimize the returns of LPs. The pool allocator relies on the solver for implementation. Project officials stated that the first LMP pool will be denominated in ETH, and will also be deployed on other major public chains.

Image Source: https://medium.com/tokemak/tokemak-v2-introducing-lmps-autopilot-and-the-dao-liquidity-marketplace-86b8ec0656a

The second product in version 2 is DAO Liquidity Market. Its function is to lease liquidity in real time from any given liquidity management pool based on transparent rates, which are determined by market dynamics.

Token Use Cases

The governance token of the Tokemak protocol is TOKE, with a total supply of 100 million tokens. Tokens used for Degenesis and CORE events are fully released, accounting for 5%; tokens for LP and LD economic rewards account for 30%, contributors account for 16.5%, the team accounts for 14%, investors account for 17%, and tokens for the community and marketing effort account for 8.5%.

The main use cases of TOKE currently are as an economic incentive for LP and LD; used to vote for the launch of the reactor; and used to vote for the distribution of liquidity between reactors and the distribution of liquidity in DEX. From this perspective, TOKE is similar to tokenized liquidity.

Currently, Tokemak attracts LPs and LDs by awarding TOKE tokens. However, a significant decline in the price of TOKE could harm the return rate and confidence of both LPs and LDs. Without economic incentives, they may not be drawn to the TOKE protocol. If this happens, the TOKE protocol may not be able to function normally and continue to assist other protocols in liquidity provision.

Current Development Status

The product that currently running on Tokemak is v1, and the official says the v2 is about to be launched. In v2, the first product to be launched is Autopilot, followed by DAO Liquidity Market. In the future, v2 will also be deployed to other major public chains.

According to the official dashboard, the total lock-up value of Tokemak is about 24 million US dollars, of which the TVL of TOKE tokens is 4.24 million US dollars, and the amount of other assets is about 12.1 million US dollars.

Image Source: https://app.tokemak.xyz/

Among all major reactors, the ALCX asset reactor has the highest proportion, with TVL reaching 3.1 million US dollars.

Image Source: https://app.tokemak.xyz/

Conclusion

The product and business logic of Tokemak are straightforward, and the product design has some highlights, which give it certain advantages in the liquidity track. And its V2 product is set to launch soon.

Currently, Tokenmak attracts LP’s liquidity and encourages LP to actively guide liquidity through the provision of TOKE rewards. However, a significant decline in TOKE price could harm the return rate and confidence of both LPs and LDs. In addition, assisting projects with liquidity is inherently risky for the protocol itself. If the selected projects are not of high quality, the pressure of the decline of the coin price will be borne by the Tokemak protocol and the TOKE stakers, so this business model seriously tests the ability of the Tokemak team to select quality projects and establish cooperation with other projects. This is the biggest challenge facing the protocol today.