Welcome to piece #4 of Fluff and Air. We love seeing protocols come up with new products and tokenomics, but we think governance models have been kind of vanilla. We’d like to spice things up a bit and present a few ideas on governance with a degen twist.
As Jai aptly put in a his goodbye post to Tribe/Rari:
“...On-chain governance is overrated (should likely be structured as a liability more than an asset) and we should be pushing for complete immutability. DeFi has lost its way with tokens and governance.”
Using DeFi witchcraft, we have devised a few methods with which we can separate the price (and speculative value) away from the governance power of any token. In our opinion, this allows speculatooors to focus on speculating and the governooors to focus on governing.
While not directly related to the ideas presented below, we thoroughly enjoyed these two articles on examining crypto governance with a Roman Law lens (Part I and Part II).
Note: This post is not financial advice, and we may hold tokens mentioned here (yes, we know it’s Goblintown).
Idea #0 - Two forms of a token, one for governance and one for yield
A simple model would be to take one token and create two forms of it, and token holders could opt-in to one and only one form (tokens put into the “governance” form does not receive yield, and tokens put into “yield” form does not vote).
If a conversion method exists that allows the two forms to be interchanged, then both forms will likely converge on the same price. However, the incentive will likely lean in favour of holding the yield version of the token over the governance version. [see foot note at end]
While this isn’t a bad model, it doesn’t accomplish our goal of isolating price from governance power, and incentivizes token holders against holding the “governance” form of the token.
Idea #1 - Protocols lending out the tokens in their treasury
As an example, right now Aave is rewarding 1100 AAVE tokens daily to stakers, for an approximate 10% APR. But are they “over-rewarding” stakers?
Suppose Aave allows the AAVE tokens in its treasury to be borrowed, with say, a utilization curve that starts at 0% borrow APR when utilization is zero and maxes out at 30% borrow APR at full utilization. When the borrow rate is less than the staking rate, then there will be arbitrageurs who borrow AAVE to farm AAVE staking rewards. Overall, this will have the effect of bringing down the AAVE staking rate and bringing up the borrow rate. Effectively, the Aave treasury will be “taking back” the excess staking rewards that it is releasing to stakers.
One interesting thing to note is that the arbitrageurs in this case are not exposed to the price movement of AAVE (read: earning delta-neutral yield position that has governance power).
As a fun thought experiment, what if Aave were to launch today and all AAVE tokens are only accessible through borrowing? Then speculators would be deterred from holding AAVE as you need to pay borrow fees to access AAVE. Perhaps we also require borrowers to put down collateral in something that could benefit the protocol, maybe ETH, BTC, stables. So effectively, anyone who wants the staking rewards or the governance power must also provide liquidity to Aave. Effectively, this is like liquidity mining, but the protocol would pay *much less* than doing emissions straight-up to attract liquidity.
Enabling borrowing may be a controversial point, because borrowing also enables people to short sell the token, putting downward pressure on price. We will stipulate that a good enough project will eventually get listed on CEXes like Buy-nance and Effty-x, and the whale farmooors will use the CEXes to short the token into oblivion anyway. Also, when shorting is done through borrowing tokens from the treasury, then at least the treasury is making some income, but if the shorting is done through a CEX, then all the fees are going to that CEX and not the treasury.
On a serious note, enabling people to hedge is actually very important for price stability. If people can only go long or go home, then when the markets turn downwards everyone will be selling all at once, aka (-3,-3).
Voltz Protocol, Euler Finance, Rari Capital are examples of protocols that we think are doing cool things to enable permissionless lending markets as well as interest rate swaps.
Idea #2 - Governance Dollars
Continuing down the line of thought to create a delta neutral position while earning governance power, what if we hedged a spot position with a short perpetual position?
We can create “governance dollars” (we dub them Gov Dollars) by separating out the price from a token by hedging an equal amount using a short perp. Theoretically, we could create a unique Gov Dollar for every token out there.
This has several attractive features, the main one being, you can retain some governance power while holding a delta neutral position. Broadly speaking, short perps tend to have positive funding rates (longs pay shorts), which turns Gov Dollars into yield bearing stablecoins. If the underlying token also has some sort of yield (staking, revenue sharing, vote bribing), then the yield will hopefully offset any periods where perp funding turns negative.
The more Gov Dollars are minted, the more underlying tokens need to be locked away (lower circulating supply = boolish for price?). When the token price moves, the long and short need to be rebalanced so the short doesn’t get liquidated. Ideally, the staked token itself is used as collateral on the perpetual platform so liquidation doesn’t occur.
If periodic rebalancing of the long and short is enabled, then when the underlying token goes up, the Gov Dollar gets less voting rights. The reverse is also true, if the underlying price goes down, the Gov Dollar gets more voting rights. This usually works in our favour as most gov tokens are down only. We’d love to see the day where tokenomics are fixed so that Gov Dollars don’t make it beyond the cradle of ideas.
Note: we could also create Gov Dollars that do not rebalance. This will lead to a constant amount of underlying tokens (and thus voting power) per Gov Dollar.
With rebalancing, we accumulate more votes per Gov Dollar when the price of the token goes down. Without rebalancing, our number of votes are fixed per Gov Dollar. It would be possible for both forms to exist side by side.
Viewed in a different light, Gov Dollars are simply UXD-style stablecoins which combine a spot long with a perp short while retaining governance power. Then, we can create Uni V3 or Curve pools between your Gov Dollars of choice and any stablecoin for efficient swaps.
A few examples and thought experiments to illustrate potential benefits of Gov Dollars.
Using SUSHI as an example, let's hold some xSUSHI and short an equal amount of SUSHI to create Sushi Gov Dollars. If SUSHI price was to double, it would have no effect on the value of our governance dollars. However, xSUSHI earns yield in the form of SUSHI, SUSHI price doubling leads to our yield being doubled as well.
Governance dollars allow a way for people to speculate on governance power in a protocol, separated from price. If SUSHI continues to go up, the amount of SUSHI backing each SUSHI governance dollar gets lower, diluting your voting power. Conversely, if SUSHI goes down in price, then the amount of SUSHI backing each governance dollar increases, causing your voting power to go up.
Say a major hedge fund acquired a major chunk of a popular DEX, let’s call that Sashimi, but the fund also invested into an alt-L1 called Moona with a community of Moonatics. If MOONA blows up, then the hedge fund needs to sell their SASHIMI to remain solvent, thus crashing the price of SASHIMI. If we were Sashimi bag holders, then we'd be dragged into becoming community members by way of financial contagion from some other party that took too much risk and blew up.
Participating in governance should not expose the community to poor decisions made by other community members on matters unrelated to the project.
Say Sashimi has bad tokenomics and value accrual, and price action is down only. it might be possible to put forth proposals that have a good chance to turn Sashimi around. Wouldn’t it be better to participate in this governance decision without needing to take on the price risk?
Of course, reasonable counter-arguments are that gov dollars remove skin in the game, as well as potentially favour whales. Without rigorous proof, we’d like to counter that the retail (“community”) are usually the most vulnerable and sensitive to financial losses (compared to large funds and whales), and that by offering a method to participate in governance without risk of loss is actually more fair to retail.
Suppose the SASHIMI price keeps plummeting. If the market cap of SASHIMI is decreasing, our share of Gov Dollars will be increasing relative to the market cap, then we gain a larger proportion of votes. Suppose further that the market cap falls low enough that our gov dollars make up 50% of their voting power? Then we can use governance to take control.
Gov Dollars enable us to comfortably hold a project to zero. And at some point before zero, we might have accumulated enough governance power to put forth proposals to redirect the project.
The main significance of this idea is that if you want to participate in governance without being tied down to bad tokenomics or price volatility, you could do so.
As an exercise for the reader, what if we used short perps denominated in ETH? Could it be possible that we created “synthetic yield bearing ETH” tokens that hold governance power over your protocol of choice? Interdasting, wouldn’t you say?
Idea #3 - TimelessFi-style token splitting
Currently, most crypto protocols are single-token protocols. Governance and revenue are both rolled up into one token. We propose using a mechanism like in TimelessFi to split these singular tokens into PYTs and NYTs. You can read about how the PYTs and NYTs relate to each other on the TimelessFi blog.
To make a small modification on top of Timeless, the PYT portion would be used to accrue yield back to holders, and the NYT portion would be used for governance. To make the distinction, we will now call this PYT portion RevT (Revenue Token) and call this NYT portion GovT (Governance Token).
So a single underlying token deposited into this app would output 1 RevT and 1 GovT, and returning both 1 RevT and 1 GovT allows 1 underlying to be redeemed.And we can create liquid markets to freely convert the underlying, RevT, and GovT.
We predict that pure profit maxis would deposit the underlying and sell all GovT for more RevT, in order to maximize their yield. However, it would still be possible for GovT to gain yield if there are vote-bribing mechanisms in place.
Imajin a protocol that hands out liquidity mining rewards using RevT only, so that the liquidity miners don’t get governance, but the GovTs are airdropped as responsibility to users who fit other criteria. Since most liquidity is mercenary, we have avoided handing over governance power to mercenaries while still providing incentives.
If the protocol does token buybacks, then the protocol could choose to say, only buyback GovTs. If the protocol then burns 1 GovT, then 1 RevT can never be redeemed (effectively burned). We think that GovTs will be priced significantly lower than RevTs, so buyback-and-burn of GovTs should be much more capital efficient than buyback-and-burn the underlying. Magical innit?
You might be thinking now, “but the prices on GovTs are still not stable, you are exposed to the relative price movements between RevT and GovT, on top of the price movements of the underlying. I thought you wanted the tokens with governance to be stable so people can hold them with less risk?”
Glad you asked! Because we have composability on our side.
Composability is helluva drug
What if we combine ideas #1 and #2? We can create lending markets for governance dollars.
What if we combine ideas #1 and #3? We can create lending markets for govTs and RevTs.
What if we combine ideas #2 and #3? Well, there’s something cool here too.
By building PYTs and NYTs on top of governance dollars, this allows for an unusual form of leverage. You have a stable underlying, and can still separate out the RevT and GovT, with the condition that:
1 RevT + 1 GovT = 1 underlying = $1 USD worth of Gov Dollars
Conclusion
Now we have seen a few example methods that we can use to detach governance power from price (speculative potential) of a token.
We can also attach to the governance power portion to a token denominated in stables (or in ETH or anything else). Once the price volatility has been hedged out, there exists the new option to hold these Gov Dollars as a savings vehicle while being able to exercise voting power.
Splitting voting power from token price allows for increased methods of financial speculation. Also, any tricks applicable to stablecoins will also work on Gov Dollars, such as low slippage swapping (e.g. Curve, Uni V3, etc) and lending/leverage (e.g. Alchemix, Abracadabra, etc).
If you’re building out projects along these lines, please feel free to slide in our Twitter DMs.
Foot note
By the way, the ideas above seemed new to us, but upon some light research, we discovered that very similar ideas already existed in tradfi.
See threads here:
and here: