The Incentives Flywheel: Vote Incentives and Interest Rate Options
July 22nd, 2022

We’ve processed millions of dollars worth of vote incentives over the past six months. How could we use additional DeFi legos to bring them to the next level?

Dopex’s Interest Rate Options

Dopex’s new release, Curve Interest Rate Options (IRO), are financial derivatives where the underlying asset is the yield on any Curve liquidity pool. They’re like their TradFi counterparts, but they’re permissionless and entirely on-chain. Like traditional options, traders have the ability to purchase existing contracts or write their own calls and puts, where the writer has complete freedom in specifying strikes, spots, expiry dates, and leverage. They are the latest addition to the Curve ecosystem and make it even more sophisticated.

Why do these work?

Yields on Curve pools are so unpredictable—yet so integral—to cash flow. For example, while increases in a pool’s liquidity (TVL) are always welcomed, they may dilute yields to an individual if emission allocations are held constant. Admittedly, gauge votes can solve this problem, but no gauge is ever guaranteed a larger piece of the emissions pie. Further, Curve APYs are subject to the price of Curve, which goes up or down with some correlation to the macro environment.

Curve IROs normalize these externalities. With a simple strategy, protocols and individuals can hedge against losses incurred by weaker pools, or even vote strategically to equalize information asymmetry. Curve IROs are a tool to remove some of the uncertainty from gauge votes, and where uncertainty remains, they are a tool to capitalize on it.

But IROs run deeper than just hedging. If you want to truly unlock the full potential of IROs, a strategic combination with the Pitch meta-governance ecosystem is in order.

Vote-Incentive Strategies with Pitch

Last week, we wrote about how the incentives economy wields the power to alter human incentive structures in DeFi governance. This week, we expand on this idea by noting the incentive economy’s ability to help participants leverage information asymmetry. This is made possible by combining Dopex’s IROs with Pitch’s incentives marketplace and staking services. Indeed, Dopex IROs can augment liquidity pool yields earned from pitched incentives and may subsidize gauge vote costs. 

A simple workflow of this two-prong process illustrates our point. 

Suppose Protocol A occupies 10% of the Curve emissions gauge and is seeking to gain 11%: a net 1% increase. It may turn to Pitch to incentivize veCRV holders to vote for its gauge. We may further assume that Protocol A is relatively confident in its ability to sway the gauge weight with this method, and is thus expecting higher APYs for its liquidity providers.

However, to further boost its gains, Protocol A may buy calls on its LP yields, thus offering the protocol a dynamic settlement reward provided the option expires in the money. Protocol A is, in effect, leveraging its yields while minimizing direct exposure to large losses that come with typical leveraging. Protocol A could augment this strategy by buying puts on other gauges that it suspects will see decreased yields resulting from Protocol A’s gains.

Now suppose that the epoch has ended and the option has, in fact, expired in the money. Protocol A has increased its relative gauge weight, increased its yield, disbursed voting rewards on Pitch, and will enjoy the settlement rewards from the successful call option. A converse strategy could be used to hedge this yield as well.

Thus, the strategic marriage between Pitch and IROs accomplished a few things. 

  • As normal, Protocol A increased its gauge weight by incentivizing gauge votes in its favor using Pitch’s governance console
  • Unlike before, however, Protocol A safely and effectively leveraged these gains with call options, collecting settlement rewards as well.
  • And, Protocol A has protected itself against information asymmetry by hedging in both directions, speculating on increases in its own yield and decreases in other gauges’ yield, too. 
  • Finally, by leveraging IROs with the Pitch incentives marketplace, Protocol A enjoys its significant advantage over other protocols vying for emissions who are pitching and earning yield conventionally. **

The use of Pitch’s vote incentives marketplace, staking services, and IROs provided Protocol A with previously unseen vote-incentive strategies. This is capital that may then be transferred to the Frax ecosystem as pitchFXS or used for further incentives on our platform, furthering the flywheel. 

Why Now?

With the FRAXBP now live and new metapools surfacing weekly, there is no better time to use this strategic workflow than now. It comes at a time where risk mitigation is crucial and market intelligence is paramount. The Pitch-IRO synergy provides both of these benefits. But the benefits extend to DeFi more broadly, too.  

Advantages to All, Both Big and Small

First, it is good for the big and small players by making the risks of information asymmetry less costly. This is particularly important for individual voters who cannot bear the costs of miscalculations due to faulty market intelligence. For larger players, it minimizes the risk of an unsuccessful incentivization campaign. For example, if Protocol A does not increase its Curve APY, it can hedge the loss with puts on that same pool.

Second, the Pitch-IRO symbiosis encourages more vote incentivization than seen currently. Regular pitches can become extremely costly, but by leveraging IROs with strategic incentives, protocols reduce their overall cost of pitching by increasing profitability at the end. Vote incentives increase the likelihood that a protocol receives a larger share of Curve emissions, but pairing IROs with the pitch means that protocols can hedge their losses, increasing the stability of the strategy and contributing to its longevity. 

Plus, the revenue stream from ITM options could entirely subsidize future pitches, meaning a protocol would not need to think twice about incentivizing with large rewards on a regular basis. 

Vitalizing a New Economy

IROs affect people not involved with gauge voting or their incentives at all – it creates an entirely new options economy. Anyone who holds the underlying assets—in this case, LP tokens—wields the power to sell contracts to protocols looking to augment their gauge vote yields, further intertwining the meta-governance and IRO economies.

These individuals—or even DAOs—would link two booming sectors in DeFi to spark and sustain innovation in both spaces. This would pay off immensely for all those involved. Writers earn sizable notional premiums and slashed deposit rates with generous opportunities for leverage — up to 500x. Options writing creates additional income for liquidity providers on top of the yield and boost they receive simply for providing liquidity. Using IROs in the incentives marketplace thus allows providers to exercise their LP tokens beyond lending and trading.

The Pitch-IRO symbiosis combines two existing and tested technologies to further enhance DeFi governance, letting protocols and users hedge and/or leverage their bets on the future of liquidity.

How will you be pitching next epoch?

Learn More

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All Content in this publication is information of a general nature and does not address the circumstances of any particular individual or entity. Nothing in this Post constitutes professional and/or financial advice, nor does any information therein constitute a comprehensive or complete statement of the matters discussed or the law relating thereto. 

There are risks associated with investing in cryptocurrencies and participating in decentralized governance. Pitch encourages all interested parties to undertake appropriate precautions before making any investments or participating.

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