There’s no doubt about it, seigniorage coins are the new rage in DeFi. Their growth in the last few months has been staggering — consider the current market leader, Empty Set Dollar (ESD). The project was bootstrapped at launch in October 2020 and is currently sitting at nearly $500m market cap, giving it a market cap rank of 54 in all of crypto. This is no mean feat, especially since the “stablecoin” has zero assets backing it.
Since then there has been an explosion of new seigniorage projects, mostly either forking Empty Set Dollar or Basis Cash. But this article is not about how these projects work. There is plenty of information out there already. This article is specifically about the little known hidden truths about the yields available for LP bonders in ESD and its forks, particularly in bootstrapping / early phases of these projects.
With ESD and its forks, bonders are rewarded in expansion phase by either joining the DAO pool or the LP pool. Typically, more rewards are allocated to DAO while LP enjoy shorter locking periods. DAO rewards are also directly added to the DAO balance, meaning that they autocompound. On the surface, it appears that in return for longer locking periods, DAO will net you more gains with the power of compound interest. It is therefore common for early apes to jump in to the DAO pool. However, things are not necessarily as they seem.
For the sake of demonstrating an example, I will use True Seiniorage Dollar (TSD), the latest ESD fork on the block (technically it’s a DSD fork, which itself is an ESD fork, but I digress).
TSD modified key parameters are as follows:
epoch length: 1hr
max expansion per epoch: 4%
DAO lock: 72 epochs (3 days)
LP lock: 24 epochs (1 day)
DAO / LP reward ratio: 60% / 40%
At this point, if you don’t know what any of the terms above means, then you should read up more on how the ESD type of seigniorage coins works. This article assumes that you are already familiar with them.
Quick example of how the parameters work: if current supply is 1000 TSD, and 100% of the supply is bonded in DAO and LP, then the DAO pool will get 24 TSD in the next epoch while the LP pool will get 16 TSD in the next epoch. Of course, it’s unlikely that 100% of the supply to be bonded, so the actual rewards will typically be higher. This is because in expansion phase, the supply will increase by 4% regardless of how many people are in the pools. As an extreme example, if only 1% of the supply (10 TSD based on supply of 1000 TSD) was bonded in DAO, the reward for the next epoch does not change — it will still be 24 TSD for the pool. At that point the 10 TSD bonded in DAO would be earning 240% per epoch.
So now comes the first lesson. Yes, LP pool only gets 40% of the rewards while DAO gets 60%. But if there is double the amount of capital in DAO as there is in LP, guess which pool will give you the higher yield?
This is the reason why you will typically see higher yield in LP than in DAO in early stages of ESD seigniorage projects. It’s simply because most people ape into DAO first. At this time of writing, TSD DAO is yielding 3.91% per epoch while LP is yielding 10.27% per epoch. Note that this actually suggests an oversubscription in the DAO pool — i.e. slightly more than 60% of the supply is bonded in DAO, which is why the rewards become diluted to less than 4% per epoch.
Ok, so what about compound interest?
I’m glad you asked. This is perhaps the most misunderstood concept (or closely guarded secret for those that understand) in this type of project.
DAO rewards are directly added into the bonded balance, which means that they autocompound with every epoch. No arguments there. LP rewards are instead put into a reward pool, which must be manually claimed. This must mean that LP rewards do not autocompound, right?
Wrong.
What?
Let’s consider where the rewards come from. In seigniorage projects that are expanding, the total supply is expanded by a set percent every epoch and rewarded to two separate pools. Let’s again assume a current supply of 1000 TSD in the TSD example above. For simplicity, let’s assume that DAO is yielding 4% per epoch, and LP is yielding 8% per epoch, and there is no current earned or claimables in LP. This means that:
60% of supply (600 TSD) is bonded in DAO;
20% of supply (200 TSD) is bonded in LP;
20% of supply (200 TSD) is not bonded in any way.
Next epoch’s reward will therefore be 24 TSD to DAO pool and 16 TSD to LP pool. The DAO pool will then have 624 TSD, the LP pool will still have 200 TSD, but will have 16 TSD earned, which can be moved to claimable through unbonding. So what happens in the next epoch after that?
The total supply is now 1040. Expansion rewards will be 41.6 TSD, with 24.96 TSD going to DAO and 16.64 TSD going to LP. DAO is getting 4% again this epoch, based on the autocompounded amount of 624 TSD in the pool. If you use the previous epoch’s balance as the principal (when the DAO pool balance was 600 TSD) to calculate yield for this epoch, this epoch’s yield is 4.16%.
Now let’s look at LP. If you count only the bonded LP (i.e. same balance as previous epoch), the LP pool is getting a yield of… 8.32%, or still exactly double of DAO. Take into account the 16 TSD earned though, and you get about 7.70%. What is happening here?
I won’t go into the complexities of the maths involved. The short answer is that your rewards are being autocompounded simply by the fact that they comprise a % of the supply, and the supply is expanding every epoch. In other words, your rewards are calculated and comes from the expanding total supply, and NOT your capital invested.
Now, in the LP case, because LP is getting inflated yield from being undersubscribed, the compound amount is “diluted” compared to your LP’s inflated yield, because the compounding is based on the same 40% going to LP every epoch, regardless of the % yield you are getting in LP. The effect is that, for the rewards you get above 4% in LP, there is no compounding; but for the first 4% every epoch, the rewards compound themselves within the rewards pool.
Don’t believe me? Let’s try the calculations again assuming that LP yield is the same as DAO yield, at 4%. At 1000 TSD supply, that means:
60% of supply (600 TSD) is bonded in DAO;
40% of supply (400 TSD) is bonded in LP;
No supply unbonded.
The next epoch would yield 24 TSD for DAO and 16 TSD for LP. Do you notice it yet? The rewards are the same for each pool in TSD terms, regardless of how much supply is in each pool. Thus, the rewards for the epoch after that will still be 41.6 TSD, with 24.96 TSD going to DAO and 16.64 TSD going to LP. The yield for this second epoch compared to the first epoch capital is therefore 24.96 / 600 = 4.16% for DAO, and 16.64 / 400 = 4.16% for LP. If you take into account the first epoch rewards, then the yield for the second epoch is 24.96 / 624 = 4% for DAO, and 16.64 / 416 = 4% for LP. They are exactly the same, and both are autocompounding.
The layer of complexity, and thus the game being played with LP, is the % share that you hold within the LP pool. If no one claimed rewards ever in the LP, then the LP pool will have autocompounding rewards that exactly mirror DAO rewards, up to 4% per epoch. However, if one person claims the reward and then puts it back into LP, that person now holds a higher % share of the LP pool and will therefore get a bigger share of the reward. Other LP bonder’s rewards drop, not because LP rewards are not autocompounding, but because their shares are being diluted. THIS is the reason why LP need to play the reward claim game. It also means that the best strategy with LP is to stagger your entry into multiple wallets so that you can continuously claim rewards and provide more into LP. Depending on your plan, you may not wish to provide all your rewards back into LP each time, but the continuous provision into LP is what will earn you maximum yield and take full advantage of the hidden LP compounding.
This is not an article to spoon feed you a strategy for LP into ESD type seigniorage coins, although you should be able to devise a profitable one based on the information revealed. I will therefore not go through a step-by-step, but in light of a lot of misinformation in the community, I will just point out that with all of the ESD forks, you can unbond and bond within the same epoch, which moves your earned rewards to claimable AND keeps you earning rewards while you wait for your claimable to be unlocked. Your LP bonding timer will be reset, but you can also claim your reward / choose to provide at the end of the lock period, or do a combination of the two.
This is merely a demonstration of mathematical principles and not intended to be financial advice. As always, DYOR and don’t just listen to a dark ninja on the internet.
