Authors: blakewest and mikesall, co-founders of Warbler Labs
Summary
After some analysis, it became clear that it’s possible in certain states of the Senior Pool for Backers to have lower APYs than Senior Pool Liquidity Providers (LPs). This would break the risk / reward relationship between Backers and LPs, and could effectively block any new deals from happening. To correct this, and to make the decision to be a Backer vs. an LP an easier mental decision, this proposal suggests letting Backers participate in Staking Rewards liquidity mining (which is currently just for the Senior Pool). This would be in addition to the existing Backer Liquidity Mining that is set to go live very soon.
Motivation
- Ensure Backer APY’s are always higher than Senior Pool APY, so that the risk / reward tradeoff is always consistent between LPs and Backers
- Make it an easy mental calculation for Backer’s to compare the yields on Borrower pools vs. the Senior Pool. Under the new proposal Backers always get what LPs get, plus extra rewards.
- Reduce system fragility. As it stands, if the Senior Pool is at the target, then Backers will have a higher reward and things are fine. But if the Senior Pool is decently below its target (as it is now), then Backers can actually have lower rewards, which breaks the economic model of the system. This change makes such a state impossible, thereby enhancing the robustness of the system.
Analysis
Note: the numbers in the spreadsheet make assumptions and are based on static values, so the exact APYs themselves are not what’s important. Focus on the relationship between Backers and LPs.
We did an analysis of what APYs Backers would get with the Backer Liquidity Mining, and how that compares with the Senior Pool. What’s important about the analysis is the relationship between Backers and LPs, as that relationship is core to how the economics of the protocol itself operate. Backers always take more risk, have less liquidity, and do more work. So, they should always be compensated more. However, the analysis revealed that if the Senior Pool is solidly below its target value, then the Backers could end up receiving less than LPs.
The spreadsheet shows example numbers (roughly based on Goldfinch’s current situation) where the Backers could end up receiving around 30% APY, while the LPs would receive 58%. Clearly this doesn’t work.
However it also shows that if you implement this proposal, the LPs’ APY would fall to 47%, while Backers would receive 71% APY (about 1.5X higher returns). That ratio would continue to increase as the Senior Pool gets closer to its target (ie. Backers make comparatively more as the Senior Pool reaches its target). We think this is a more reasonable ratio to reflect the extra work and risk involved with Backer participation.
Importantly, under the new proposal it would be impossible for the Backers to ever receive less than LPs. That is because Backers would be guaranteed to get at least the same liquidity mining rewards as LPs, plus both a higher organic yield (due to the Backer Boost) and the additional Backer Liquidity Mining.
Moreover, we think this reflects a much more sustainable relationship between the LP vs. Backer APYs. Backers need to receive a substantively higher APY to incentivize them to do the extra work and take the extra risk of participating in borrower pools.
Specification and Requirements
Specifics
- All Backer Pool Tokens would be redeemable for Staking Rewards, the same as LPs.
- They would accrue Staking Rewards from the time of drawdown on a Borrower Pool (when capital actually becomes at risk) to the time of final repayment.
- Backers only accrue Staking Rewards while the Borrower Pool is in good standing (ie. Borrower is not in default)
- All existing Backers would also be eligible to start participating in the Staking Rewards.
- A migration function could make it such that existing Backers start the liquidity mining retroactively as of the time of token launch (because that is when LPs started their liquidity mining)
Benefits
- Guarantees that Backer APYs are always higher than LPs, ensuring the relative economics stay intact.
- Reduces cognitive load when making a decision to be a Backer vs. LP. The story becomes clear. “Backers get what LPs get plus extra”
- Increasing Backer APYs should generally help pools get filled faster.
- Doesn’t require budgeting additional tokens from the treasury
- Can be built quickly. Limited additional complexity or risk to the smart contracts.
- All existing Backers will be able to participate in the new rewards
Downside
- Dilutes LP rewards - As Backers stake their principal amounts, it would add to the total dollar amount being staked, and thereby reduce overall reward rate per dollar from the Staking Rewards contract. However, Backers will always be a relatively small percentage of total capital, so the dilution would be limited. (See “Update” below)
- Spends tokens at a faster rate. The Backer Liquidity mining rewards will spend it’s tokens faster, because it will always ensure that it’s greater than the LP rewards (+ the same Backer Liquidity mining rewards described in other proposals)
Voting
“Yes” - Enable Backer’s to participate in the Staking Rewards.
“No” - No change
Resources
UPDATE - After some discussion with Warbler engineers, the implementation here will likely make it such that the Senior Pool rewards are not diluted. So that is no longer a downside. The new downside is that the protocol would spend slightly more tokens overall.