Avoiding a Price/Liquidity Death Spiral

LuaSwap was launched by the TomoChain team. It is a very clever idea for bootstrapping liquidity onto Tomo. The Lua dev team (Tomo) wins just by getting liquidity onto Tomo and LuaSwap. In theory, the value of LUA could fall to 0, and that wouldn’t be an issue for them as long as LPs are incentivized to remain on TomoChain (e.g. swap fees paid in TOMO).

That said, let’s hope they do care about LUA market cap (for the sake of both the dev fund and LUA holders, like myself). Market cap of LUA will be supported by two main things:

  1. TVL on LuaSwap
  2. Utility or tokenomics of LUA

Therefore, any strategy for the success of LUA must consider both of these factors (Charging 10% swap fees destroys 1, while having no financial benefits for holding Lua destroys 2.)

(Note: I use “LP” for both liquidity providers and liquidity pools).

Theses:

  1. Liquidity follows yield. That’s why we’re even having this conversation.
  2. Lua-Token pairs are high-risk because of price uncertaintly of Lua. (And therefore the risk of impermanent loss compounding the risk from Lua exposure)
  3. Lua-Token TVL is currently incentivized by 4-digit APY.
  4. About 25M of 32M circulating supply is currently invested in LPs

Conclusion: as yields fall significantly during weeks 5-7, liquidity will begin to migrate away from LuaSwap. Migration implies exiting LUA LP pairs and then exiting LUA. This will cause a dump and LUA price will fall. This causes yields paid in LUA to drop, accelerating a death spiral of TVL. (SUSHI fell to 1/5 of its peak TVL). This is bad for LUA holders, bad for Luaswap, bad for TomoChain. When this happened to SUSHI it was still one of the first in the space. Now there are AMMs popping up on every chain and L2 Ethereum solution.

The LUA community and team would benefit by addressing this ASAP, creating value in the LUA token to prevent the death spiral.

Possible value propositions for LUA:

  1. LP exit fees. This is the only thing I see on the Medium paper. Suppose the 0.5% LP exit fee is implemented and there is a complete turnover of liquidity every 3 months. Being generous and assuming no death sprial, at current numbers that generates 0.5% return (times 4) on $30 million of TVL. This equals about 600,000 per year. The circulating supply of LUA in 8 weeks will be about 200 million. That’s .003 per LUA or about 2% yield at the current LUA price. ARE WE JOKING? No LUA liquidity will be motivated by a 2% yield. Verdict: this is far from sufficient to motivate holding LUA and maintaining LUA pairs.

  2. LUA vault for a share of swap fees. This is Sushi’s approach (0.05%) In rough numbers, they’ve collected about $10k in the last 24 hours for the SUSHI vault. With the current amount of locked Sushi, this is a yield of around 15% APY for locked SUSHI. This has probably helped stabilize the price of SUSHI.

  3. Buy and burn LUA with a share of swap fees. This is an alternative that could also help stabilize the price of LUA. The advantage over a vault is that LPs whose LUA are in pools would also benefit from this, whereas they are not incentivized in the former.

  4. Route all trades through LUA. Require LUA as the base of any pair. This would create value for LUA LPs through trade fees, and therefore support LUA value. This might discourage LPs who don’t want to buy LUA, but perhaps this could be mitigated by allowing 1-sided liquidity provision? There could be a LUA vault for those who want to deposit LUA, and if someone wants to add one sided liquidity of another token to a pool, it could be matched with liquidity from the vault. This would probably require oracles or something to avoid manipulation.

  5. Discounted swap fees for LUA stakers. This would probably only generate a noticeable return for whale traders.

What other ideas do you have? I’d love to see Tomo/Luaswap succeed, and my vested LUA be worth something in 6 months!

Hey folks, I haven’t seen any replies to this, and I don’t think there have been any announcements of LUA utility. As I predicted, but sadly much faster, TVL is already down about 30%.

Hi I read your suggestions with interests. Some will be incorporated in the LuaSwap V1.0. We plan to launch it on October, 30. The final specification will be announced next week.

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Thanks Long. I’m glad to hear that! I think announcing utility updates for $LUA will help maintain (or boost!) TVL. Can anything be leaked now to help boost confidence for LUA LPs, and if not, what day do you think you’ll make announcement?