Maximizing LP Token Incentives

The liquidity providers (LPs) in a pool can generally receive basic token incentives in two parts:

  • Trading fee from users who wish to perform swaps; and/or

  • Additional reward from the third-party interest-earning protocols (such as Compound/AAVE).

However, the drawback of supporting the rewards from the third-party interest-earning protocol is that significant gas is incurred by moving the tokens to/from the protocols. To address such concerns, Curve.fi offers the pools for liquidity providers (LPs) with and without participation in third-party interest-earning protocols at the cost of lower liquidity.

Dynamic Cash Reserve Algorithm

Smoothy addresses the concerns by using a dynamic cash reserve (DCR) algorithm. The basic idea is that Smoothy will reserve about 10% of the token as cash in the pool and deposit the rest 90% into the third-party interest-earning protocols. If a swap results in

  • The cash reserve is greater than 20%; or

  • There is insufficient cash reserve to complete the swap

Smoothy will perform a rebalance so that

  • If the cash reserve is greater than 20% of the token, 10% will be retained as cash, and the rest of the cash reserve is deposited into the underlying protocol to earn interest; or

  • If the cash reserve is insufficient to complete the swap, extra tokens are withdrawn from the underlying protocol so that 10% of the token becomes reserved cash after the swap.

As a result, if as long as the swap does not trigger a rebalance event, the gas cost of the swap can be extremely low by moving reserved cash owned by Smoothy and bypassing gas costly withdrawal/deposit operations of underlying protocols.

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By putting 90% (expected) of the tokens into the third-party interest-earning protocol, the LPs of Smoothy can maximize their token incentives by

  • Trading fee (including swap fee/penalty fee); and

  • Interest earned from the third-party protocols; and

  • Penalty fee incurred by slippage.