Protocol Mechanics
Given the asymmetric needs of DAOs and liquidity providers, Rift is able to redistribute the risks and rewards of liquidity positions on decentralized exchanges so that these parties can work together collaboratively rather than competitively. Rift empowers DAOs with sustainable token liquidity while simultaneously improving the return profile for liquidity providers.
The Rift Protocol can be applied to arbitrary ERC20 tokens, but for simplicity in this documentation, we'll discuss the protocol in terms of establishing liquidity vs ETH, as this is the most common liquidity pair in DEXs.
DAOs use the Rift protocol to deepen token liquidity without having to give up ownership of their tokens as they do with liquidity mining.
DAOs can deposit their tokens into a Rift Vault. These tokens sit in the vault until a liquidity provider deposits ETH into the same vault, at which point the tokens are combined in equal amounts and placed in a DEX (Uniswap, Sushiswap, etc) to deepen liquidity for this pair.
Token pairs remain activated as liquidity on DEXs until either liquidity providers or DAOs wish to withdraw their tokens.
Upon withdrawal, positions are rebalanced according to a few simple rules, described below.
Liquidity providers use the Rift protocol to double their returns and protect themselves from the downside risk of impermanent loss.
Liquidity providers can deposit ETH into any vault containing DAO tokens. These deposits are then paired with the DAO tokens and activated as liquidity in DEXs.
If more value is deposited in ETH than in DAO tokens, there will be excess ETH in the contract after they're paired up in the DEX. This is fine as these ETH deposits will remain in the vault until more DAO tokens are deposited or until the depositors choose to withdraw. Returns are distributed evenly across all LPs.
All swap fees from the DEX LP position (in excess of impermanent loss) are given to the ETH depositors. Despite providing 50% of the capital, DAOs claim 0% of the rewards. This allows liquidity providers who provide the other 50% of the capital to claim 100% of the returns. Therefore, using Rift, liquidity providers earn 2x rewards. Their position is analogous to a free loan on the DAO token, without any risk of liquidation.
For LPs, depositing into a Rift Vault is more profitable and less risky than depositing liquidity into the DEX directly.
Vaults are perpetual. They operate on an epoch-based system to prevent known DEX attacks like front-running. Upon withdrawal, returns are distributed to both sides according to the below rules. Any deposits that were not withdrawn remain in the DEX as activated liquidity for the pair.
Rift Vaults implement an interest rate floor for the ETH side of the Vault, mitigating the risk of impermanent loss for liquidity providers. Initially, this floor is set to 0 – meaning the LPs will always receive back at least their initial deposit. Now DAOs are able to set non-zero APY floors for liquidity providers for their Vaults. The APY floors can be set to competitive rates to attract ETH deposits. This means in case of impermanent loss, liquidity providers will get earn at least this target APY floor, except in the most extreme scenarios. The LP side will fail to hit its target floor if and only if the paired token falls in price ~75% relative to ETH.
Additionally, it implements an interest rate ceiling for the DAO side – so that any yield in excess of the ceiling is used to reward LPs. Initially, the ceiling is set to 0. However, this ceiling reflects the liquidity provider APY floor set by the DAO. Parameters will be tuned over time for optimal allocation of risk and reward.
So, the three rules defining the return profile for Rift's initial vaults are the following:
- 1.The ETH side gets back at least the APY floor.
- 2.The DAO side gets at most their ceiling.
- 3.The ETH side gets any additional yield beyond requirements (1) and (2).
Therefore, if yield exceeds impermanent loss, LPs take on the IL but still profit. If the impermanent loss exceeds yield, DAOs take on the IL.
Below, we can see the impermanent loss experience by (1) a standard LP position, (2) an LP in Rift, and (3) a DAO in Rift when the Vault APY floor is set to zero.
Blue: standard LP position
Orange: LP in Rift
Green: DAO in Rift
If you'd like to dive into the details of how these curves are generated, dive into the next section.