This proposal aims to attract lenders and borrowers as well as retain AADA holders of the AADA ecosystem. This aim is achieved by incentivizing all three participants (lenders, borrowers, and holders) within the framework of a circular economy. This framework will build upon the two proposals recently approved by the DAO. Namely:
1. The treasury proposal:
(Proposal: Create a treasury and fund it using Service Fees on the AADA protocol)
2. The buyback proposal:
(Buyback Proposal #3: Implementing $AADA buyback mechanics)
The current motivation among the DAO participants is to incentivize AADA holders ONLY to ensure their retention in the ecosystem, and this motivation is enacted through the two approved proposals mentioned above. These proposals are, indeed, steps in the right the direction, and the current proposal builds upon them. The current proposal will tackle an incentive mechanism for the lenders and borrowers in such a manner that creates a circular economy that benefits the AADA holders, lenders, borrowers, and the protocol.
Because all participants are incentivized under the circular economy, increase in lender and borrower participation is expected which will lead to increase in collected fees, increase TVL, increase reward for AADA holders, increase fund for governance, and increase value of the AADA token.
Comparison between staking (or safety module) vs circular economy:
Staking / Safety module:
-incentivizes AADA holders ONLY
-reward emission is pretty fast and leads to sell pressure
-does not generate fees for the protocol
-risk is assumed by AADA holders
-incentivizes AADA holders, borrowers, and lenders
-reward emission rate is very slow so it does not lead to selling pressure (allocated tokens will not be consumed even after 20 years.)
-risk is assumed by borrowers and lenders since they are now incentivized.
-lead to an increase in lending/borrowing activity, therefore an increase in TVL, increase in airdrop for AADA holders, and an increase in AADA value.
-not done anywhere else (something new for AADA if it gets implemented).
The Circular Economy
1. Problem statement:
Currently, the AADA tokenomics allocates 34.75% AADA for staking and governance. However, the staking mechanism is unproductive and only devalue the AADA token because staking reward increases the circulating supply, and AADA holders monetize their reward by selling the received tokens. The staking mechanism just emits AADA from the reserve without generating fees. We should use the reserve to increase lender/borrower activities via an incentive program.
Think about credit cards. They have the miles program all year round. You use the card for your needs and, in return, you get miles as reward.
The circular economy shares the same principle.
This proposal adopts the mechanisms outlined in the two previously approved proposals. Namely: the collection of a network fee plus other fees, the incentivization of AADA holders using the 50% of the collected network fees, and the creation of a treasury from the other 50% of the collected network fees (which will be used for the buyback mechanism).
The current proposal recommends that the AADA staking mechanism is discontinued. Instead, the current proposal recommends that all the 34.75% AADA allocation (or whatever is left) is diverted to the proposed treasury (see the treasury proposal above) and divided into two allocations: one allocation is for governance (50%) and another for the lender and borrower incentive program (50%).
“Incentive for lenders and borrowers?”, you asked. Yes, because these participants are also important for the organic growth of the ecosystem. The lender/borrower fund is a small price to pay to increase the protocol metrics. As mentioned, these metrics are increase in collected fees, increase TVL, increase reward for AADA holders, increase fund for governance, and increase value of the AADA token.
The proposed lender and borrower incentive program is reasonable because lenders and borrowers lock funds in the protocol and contribute to the total value locked (TVL). This is the more meaningful TVL than the TVL derived from staking AADA. The lender and borrower incentive program should have about 5.04 M AADA allocation as calculated below:
29 M total AADA * 34.75% AADA allocated for staking and governance * 50% AADA allocated for the lender and borrower incentive program = 5.04 M AADA
The current proposal recommends 10% annual emission rate from this fund. The decline of the fund at 10% emission rate is given in the figure below. However, this decline will be replenished by 50% of the buyback program (the other 50% of the buyback goes to governance). In addition, the increase in TVL also increases the value of AADA which should compensate for the decline of the amount of the fund. Because of the buyback program, the fund is unlikely to go to zero.
Lenders and borrowers are only incentivized if they have an active lending and borrowing, respectively, i.e., liquidity deposits and requests are not incentivized. The duration of the lending/borrowing should never be less than 6 months in order for any participant to benefit from the program incentive. Incentives are accumulated per epoch but are paid only after liquidation or repayment.
- Program fund: 5,040,000 AADA
- Fund allocation for year 2023: 5,040,000 * 0.1 = 504,000 AADA
- Number of epochs = 73
- Rewards per epoch = 504,000 / 73 = 6904 AADA
- Total ADA lent + total ADA borrowed for epoch 1 = 1,000,000 ADA (Just for example. Also, tokens are calculated in ADA value at epoch snapshot).
- Reward per ADA for epoch 1 = 6904 / 1,000,000 = 0.006904 AADA per ADA lent or borrowed.
For the borrower:
- A borrower who borrowed 1000 ADA worth of tokens will receive 6.904 AADA as his reward in epoch 1, but he must kept that borrowing position for at least 6 months. Otherwise, his reward is forfeited.
For the lender:
- A lender lending 5000 ADA worth of tokens will receive 34.52 AADA as his reward in epoch 1. When he is repaid by the borrower before the 6-month maturity, he earns his rewards for the epochs his liquidity was borrowed. However, he must hold his liquidity deposit locked in the protocol for at least six months. Otherwise, his reward is forfeited.
Potential weakness of the proposal:
The proposal can be exploited via fake lending and borrowing. For example, wallets owned by the same entity might initiate lending and borrowing to arbitrage on the reward. This will create fake TVL which is not healthy for the protocol. However, making the lenders and borrowers commit to a 6-month locking of funds might be enough as a deterrence.
Also, the amount of lending and borrowing that can benefit from the program is limited to 20k ADA (or whatever is agreed by the DAO). For example, if there is a lending/borrowing that amounts to 1M ADA, only 20k of that will benefit from the incentive program. Why? No middle-income people can afford to lend/borrow 1M ADA.