General Overview
General Introduction
As a reminder, Tokemak orchestrates the provisioning of liquidity across DeFi by coordinating actions across Liquidity Providers (LPs) and Liquidity Directors (LDs). LPs provide assets via single sided staking into the system, and the LDs direct that liquidity to AMMs/exchanges via staking and voting with their TOKE.
LPs play a central role in the operation of Tokemak and are held sacred. The mechanics have been designed to, in combination with the deployment guardrails, mitigate potential impermanent loss (IL) for LPs while keeping the protocol in a safe operational state.
The mechanics are set up in such a way that the LPs are protected from impermanent loss (IL), which is accomplished through a surplus/deficit management, reserve and TOKE staked as collateral.
The goals of the protocol are to provide sustainable liquidity across DeFi while increasing the Protocol Controlled Assets (PCA) and protecting LPs from impermanent loss.
Basic Mechanics of a Tokemak Liquidity Deployment
The below illustration depicts the mechanics of a Tokemak deploying liquidity to an outside trading venue (while we will be focusing on automated market makers as these represent the main concern in regards to IL, the same general mechanics apply when liquidity is deployed to order book exchanges)
LDs direct the assets from LPs into Uniswap
  1. 1.
    LPs provide one-sided liquidity to Genesis Pools (the Tokemak ETH and stable
    coin pools) and the individual token reactors (assets)
  2. 2.
    Liquidity Directors (LDs) stake TOKE to the token reactor(s) and direct the
    liquidity to their chosen trading venue
  3. 3.
    The system determines the amount to be deployed according to the quantity of the asset held in the reserve (and the TOKE staked to the specific reactor), see section “Deployment Logic”
  4. 4.
    Finally, the system draws appropriate quantities of both assets from the Genesis Pools and the asset side of the reactor and deploys them as directed by the LDs
System Reserve and Operational Surplus
Operational Surplus
One of the main sources of value that is utilized to maintain or increase the PCA is the operational surplus, the surplus in asset quantities resulting from the change of their ratio occurring in AMM pools (same mechanism that results in the asset deficit).
These operational surpluses from which the system draws have to be looked at from both the reactor and system level, as the system tries to rebalance and optimize on both levels.
System Reserve
The system reserve represents the primary source of assets to be paid out to make LDs whole. As a result of the two collateralization events the system will have surplus of both ETH / stable coins and the initially supported assets in its PCA. These will be utilized in internal swaps (with e.g. assets from the operational surplus) if a loss occurs.
First the reserve is used to make LPs whole, followed by using TOKE staked to that reactor. As an ultimate backstop, ETH or stables can be drawn from the reserve, in case an internal swap for the asset in deficit is not possible. This scenario should not occur unless incorrect guardrails are put in place for the deployment, or a relative price change larger than mitigated by the guardrails occurs.
Impermanent Loss
Individual LPs usually view impermanent loss as the difference in total value of the assets deployed after shifting of the ratio of the pool assets due to a change in their exchange rate (“sell the winner, buy the loser” – very similar to a constant mix strategy in portfolio management) compared to simply holding both assets.
Tokemak views impermanent loss from the perspective of the negative change in quantity of one of the assets deployed to a AMM trading venue. In other words, Tokemak tries to ensure that LPs can withdraw the same quantity of assets they initially deposited into the system. This approach combined with other specifics of the system allows for rebalancing of assets that should only result in a net loss on the system level in extreme market conditions.
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