Hello,
I wanted to contribute because I found several essential protocols, ideas, and concepts lacking in the current conversation.
First, let’s start with Base, as building and sustaining liquidity there will be much easier than on mainnet. On Base, Aerodrome is a necessary choice to explore for liquidity building, as it captured most of the TVL on the chain and now even matches Uniswap in volume while offering exciting solutions for projects looking to grow and sustain their liquidity. It can help address all three objectives targeted by this proposal.
The need for constant product liquidity
Yes, CL is excellent and efficient, but it has many limitations often overlooked: easier price manipulation, price void zones, more complex for LPs, more onerous and complicated LP incentivization, less composable LP tokens than constant product, etc.
Reading the objectives of this proposal, they highlighted to me a need for a constant product (v2 / x*y=k) pool; here’s why:
- It allocates liquidity all along the price curve, making it much harder to manipulate the price and remarkably easier to compute the manipulation cost to a specific price based on the current pool TVL. Since the whole price curve is covered, it avoids situations where the liquidity allocated is slim or non-existent, which are the most dangerous if MORPHO is to be used as collateral.
- Since constant product pools do not require liquidity providers to monitor and manage their position, their incentivization tends to be less costly and more sustainable.
- CL can still be harnessed in another pool for maximal liquidity efficiency and pairs nicely with having a solid base of constant product liquidity.
How do we accrue the pairing asset? Option 1 - oToken
Currently, there are no/minimal ETH reserves and, thus, no potential pairing assets. However, the launch campaign could be designed to harness the option token model. The implementation would be straightforward:
- Instead of being airdropped “raw” MORPHO, farmers receive oMORPHO - “Option Morpho.”
- oMORPHO is an option to buy MORPHO at a discounted price, for instance, 50%.
- As farmers redeem their oMORPHO into MORPHO, ETH is accrued, which can be paired with MORPHO to grow Protocol-Owned Liquidity.
The above would require a minimal initial baseline of liquidity for MORPHO/ETH that can be sourced through various means but then ensure that the liquidity can grow (assuming MORPHO tokens are granted to be paired with ETH obtained and supplied as liquidity).
How do we accrue the pairing asset? Option 2 - Genesis Event
Depending on the time available until MORPHO is made liquid, we can consider other options to ensure a smooth MORPHO launch with sufficient liquidity. For instance, Gearbox explored an exciting model with its Cider event.
However, this approach does not capture permanent liquidity but ensures that sufficient liquidity is present at launch
https://medium.com/gearbox-protocol/gear-cidered-liquidity-launch-explainer-37e5882f4d91
Alternative solutions to deepen permanent liquidity without needing the pairing asset
On Base, and thanks to the Aerodrome model, we can envision other pathways to permanent or sustainable liquidity.
Acquiring AERO to lock as veAERO and secure incentives to MORPHO/ETH on Base
The first and most obvious is for the protocol to secure a veAERO position, allowing it to direct AERO incentives to the MORPHO pools on Aerodrome and earn its share of the trading fees these pools generate.
Several pathways are possible here:
- Morpho Relay Incentivization is a strategy where relays, which are veAERO voting strategies that anyone can easily join by delegating their veAERO to, are deployed for Morpho-related pools. Users who delegate their veAERO to these relays are incentivized with MORPHO tokens. This strategy gives the DAO voting power, enabling it to adjust its allocation weekly.
- Deal(s) with veAERO Whales: The DAO can approach veAERO whales to strike a deal to secure a voting baseline allocated to MORPHO-related pools in exchange for MORPHO tokens. It’s similar to solution 1, although not public and with likely fewer parties involved.
- Direct Acquisition: veAERO is NFTs and transferable. The DAO could look for a counterparty willing to exchange veAERO for MORPHO tokens. This is usually not an option for newly launched tokens, but it can be explored considering Morpho’s reputation and achievements.
- Morpho Protocol Strategy to Accumulate AERO: considering that Morpho is a lending protocol, we could also envision AERO-related strategies designed to help the DAO accumulate AERO. For instance, AERO could be enabled as collateral on Morpho(considering it has >$150M liquidity onchain, it is safe) in a custom market, which would capture a share of the interest rate paid. MORPHO incentives can be considered to make up for the LP loss.
- Similarly, the top-TVL Aerodrome liquidity pools could also be enabled as collateral, enabling LP to leverage their exposure, and similarly, the DAO to capture a share of the interest paid (would require custom development to support LP staking as collateral)
Building and sustaining liquidity on mainnet
Unfortunately, there is no Aerodrome on the mainnet. Alternatives exist, such as Curve or Balancer, but their model is much more convoluted, and their bribe efficiency is much lower; to put it simply, replicating a strategy similar to the one I suggest for Base on the mainnet would be much more costly, if even possible.
In terms of venue, on the mainnet, Uniswap (even “just v3”) remains the dominating and preferable option. Several ready-to-use options are available there to incentivize liquidity providers, such as Merkl, though they involve offchain computation and a service fee.
This is where the option model would prove interesting, as it ensures that the DAO can grow ETH reserves when oMORPHO tokens are redeemed, independent of the DEX used for liquidity. It enables an increase in the protocol-owned liquidity over time. Moreover, since this liquidity would be protocol-owned, it will be much easier to move it when needed, such as while migrating from UNIv3 to UNIv4. This adaptability of our strategies ensures the flexibility and resilience of the MORPHO protocol.
What the end-game could look like
Before wrapping up, I’d like to share a vision of the future if the right strategies are implemented now. This vision is based on the potential benefits of the proposed strategies, which could significantly enhance the liquidity and stability of the MORPHO protocol.
Assuming:
- Implementation of the oMORPHO
- Development of an Aerodrome strategy
- UNIv4 will be released in a few months
On Base, the Morpho DAO controls a sizable veAERO position accumulated thanks to a protocol-level strategy. It supports a MORPHO/ETH constant product pool, ensuring a solid baseline of several million dollars worth of full-range liquidity, making the MORPHO price harder to manipulate. A secondary MORPHO/ETH or MORPHO/USDC CL pool is also supported to minimize slippage for traders.
Thanks to its voting and oToken model, the Morpho DAO earns most of the trading fees collected on both pools. These fees are compounded into MORPHO/ETH and MORPHO/USDC protocol-owned liquidity positions, securing a growing liquidity baseline while helping the DAO accrue AERO weekly and increasing its voting power.
On the mainnet, with the harnessing of the option token model during an exciting and anticipated launch, the DAO was able to secure a sizable amount of ETH early on, enabling it to supply a UNIv3 MORPHO/ETH (wide range) sizably.
With the launch of v4, the pool was migrated, and now, it harnesses a custom hook that collects its trading fees weekly and re-allocates them as liquidity mining for external liquidity providers. This model ensures an outstanding balance:
- The DAO liquidity supply guarantees a baseline of wide-range liquidity.
- When trading activity picks up, the fees collected increase, and thus, the liquidity mining incentives posted also increase, helping to attract more external liquidity.
Parting Words
Liquidity management and incentivization are complicated and intricate topics that should not be overlooked. Liquidity-related decisions can make or break protocols. The recurring mistake we see projects making over and over again is to treat liquidity building as a cost, while in our perspective, it is an investment. Expenses are unavoidable early on, that is certain; however, with the right strategies implemented and a willingness to invest resources in the endeavor, especially early on, the costs of liquidity building can be progressively lowered, and overall, the activity can even turn into a profitable one.
A DAO/governance forum is not the ideal location for it to take place since, as you can see already, builders of various liquidity-driving-related tools quickly show up to suggest their solutions, with often minimal consideration for what is ideal for the DAO over the long term. I work at the DeFi Collective precisely to address this concern, helping maximally decentralized projects handle tricky topics such as this one. The DAO should bring knowledgeable profiles to handle such matters, as the ideal solution will likely not be devised through back-and-forth governance forum conversations.
Good luck, Morpho community, with the MORPHO genesis event and liquidity strategy; please tread carefully there. I would hate seeing Morpho becoming another “amazing protocol, useless/wasteful token” project.
