A ve(3,3) Mechanism DEX Based on SNS DAO

[ICPEx]

Recently, $THE (Thena) was listed on Binance, bringing the ve(3,3) mechanism DEX back into the spotlight. The ve(3,3) mechanism is an excellent DeFi governance and incentive structure that combines the “Vote Escrowed” (ve) mechanism with game theory (3,3) to encourage users who lock their tokens for a longer period to receive higher rewards, promoting protocol stability and long-term development. The positive feedback loop created by the ve(3,3) mechanism will provide high returns for token holders, lockers, LPs, and other participants.

The Principle of the ve(3,3) Mechanism

In the ve(3,3) model, there are three main roles for users: Locker, LP (Liquidity Provider), and Seller, each corresponding to three basic actions: Stake token, Provide Liquidity, and Sell token. The following diagram presents the results of simultaneous game theory between two users in different roles.

We can analyze a few scenarios from this model: If Player 1 chooses to be a Locker and Player 2 chooses to be a Seller, the result would be (-1, 1), where Player 2 gets a small profit. If both players choose to be Sellers, the token price will drop, and both will end up in a (3,3) lose-lose situation. However, if both players choose to be Lockers and stake their tokens, the overall token supply will decrease, the token price will rise, and both players’ voting weight will increase, leading to a win-win scenario where both players achieve the best possible outcome of (3,3).

Currently, ve(3,3)-based DEXs in other ecosystems have been rapidly developing, providing significant returns for their community members. We are eager to explore the possibility of implementing a ve(3,3) mechanism DEX on ICP. At the same time, we recognize that SNS (Service Nervous Systems) naturally has staking characteristics, so we want to leverage SNS’s features to create a protocol for a ve(3,3) mechanism DEX based on SNS. With this in mind, we have outlined the following protocol mechanism, using ICPEx as a blueprint.

The Protocol Mechanism for ve(3,3) DEX on SNS

In this protocol, three types of users are involved: Trader, LP, and Neuron Staker.

1. Trader interacts with liquidity pools on ICPEx, generating two types of fees:

• One part is the trading fee from the liquidity pool, which is reinvested into the pool.
• The other part is a transaction fee, which is used to buy back IEX tokens. 10% of the repurchased IEX tokens will be directly burned, 10% will be used to cover the Cycles consumption necessary to maintain ICPEx, and the remaining 80% will be distributed as rewards to Neuron Stakers according to their voting weight.

2. LPs can add liquidity to the pools and withdraw liquidity (including market-making earnings) at any time. Neuron Stakers can vote for the dividend pool whitelist to determine which liquidity pools are eligible for dividend distribution.
3. Every week, 0.2% of the remaining IEX in the treasury will be released, amounting to about 10% of the remaining IEX supply annually. Of this release, 50% will be distributed to LPs in spot form, and 50% will be distributed to Neuron Stakers in rebase form, based on their voting weight.

Summary of Benefits in This Mechanism

• Traders will experience the lowest possible transaction fees on each trade. Due to LPs competing for a spot on the dividend pool whitelist, LPs will provide liquidity pools with ultra-low transaction fees to attract user votes. The overall transaction fee can be as low as 0.11%, with the possibility of removing the liquidity pool’s trading fee portion later.
• LPs will not only earn market-making profits but also receive regular dividends from the treasury.
• Neuron Stakers will continue to receive voting incentives and will also earn transaction fee dividends and treasury dividends.
  
  

Future of ve(3,3) Mechanism DEX on ICP

Currently, ICP DeFi is still in its early stages, and a ve(3,3) mechanism DEX can provide significant momentum for the development of ICP DeFi. ICPEx is committed to building a ve(3,3) mechanism DEX that fits ICP’s unique characteristics, aiming to become the first DEX on ICP where governance and revenue rights are fully owned by the community.

[senior.joinu]

Thanks @ICPEx for bringing this topic to the forum!

We at MSQ were also exploring ve(3,3) and we believe that this mechanic is a must-have in the ecosystem, since the liquidity problem is really bad right now. A single successfull ve(3,3) DEX could finally accumulate all the liquidity in one place and provide both: slippage-less swaps and high returns for LPs.

So, in general, I feel very positive about you guys diving into it and trying to find a way to make it work on the IC! Thank you.

But there are details I’d love you to elaborate on.

1. Where are the bribes?

There are no bribes in this scheme, which are a vital part of such a system. Voters are not motivated to do anything beyond casting their vote for some most established pairs like ICP/ckUSDT, ICP/ckBTC and etc. As a team behind some much less established token, how can we use this scheme to reward traders and LPs of our token with a dividend cut?

Yes, we can “ask them on social media”, but there is no incentive for them to do that, unless they are sure that our pool will produce more trading fees than other established pairs.

2. What is ICPex service fee?

The description says that the trader generates two kinds of fees. One goes to the LPs and another one almost completely goes to the voters. The first one is fine, but the second one seems off.

Assuming total fees are the same as on ICPSwap, which is 0.3%, seems like 0.15% ICPex service fee (half of total) feels right. Are those fees collected in ICP?

If yes, then they will only be collected when the price goes UP (because of how AMMs work), this makes voters biased more towards pairs which are more likely to grow in price, which is not a catastrophy, but shouldn’t be this way.
If no, then you will have to sell the second token (or both of them, if the pair does not contain ICP at all) to get ICP to buyback the IEX. Which means that the system will contribute to the selling pressure of the token, which is super bad. The system should be neutral in that sense.

3. Do you have what it takes?

The success of any ve(3,3) project is mostly defined by the team’s ability buyback the token to keep the price at the same level for a long period of time.

DO NOT expect LPs and Neuron Stakers to hold IEX - they won’t do that. 90% of them will sell it as soon as they get the opportunity to do that to get some liquid token they can use to pay for their groceries and rent. You should be ready to provide enormous amounts of liquidity to the IEX/ICP pool during the unlock periods, to prevent them from dropping the price. The worse the price of the IEX, the less incentive there is for LPs and the voters, the less liquidity there is, the less trading fees there are, the less value people see in holding the token longer, the more likely they will also sell harming the price even further.

Nobody knows the exact amount of funds you will need to buy back your own token until it’s price reaches stability and becomes resilient to token unlocks. I’m not an expert in this, but at the current stage of our ecosystem, I would say that this is somewhere near $1m. This is around 100k ICP just to spend on buying it back, not including salaries you have to pay, marketing and other expenses.

Are you sure you’re able to get this funding via SNS?

4. The system don’t match team’s incentives.

Since (almost) all the service fees are used to reward neuron stakers, there is no separate income flow for the team. I assume, the team could stake their neurons as well and get rewarded by participating in the protocol just like anyone else (and they should do that). But this will put you in a bad situation. Because in order for you and you teammates to pay your own bills, you will have to sell your own token, harming your own price and degrading your own project’s efficiency.

Dfinity works this way, but this doesn’t affect the platform, because gas is paid in cycles, which is a stablecoin. In your scenario there will be a direct correlation between your profit and the efficiency of the DEX, which is super bad. The more you earn, the lower the price of IEX, the worse the performance.

5. Rebasing mechaninc is a mystery

This is simply a technical thing. I assume, you have this already figured out, but just keep some details to not overflow the post with them.

SNS’s tokens won’t work the same way as veTokens. You need some kind of conversion between them. And since there are also neurons involved you have to somehow convert regular neurons into veNeurons to get rebasing work as expected.

Could you please explain, how that would work?

---

I believe, you should work a little more on that design and make it more similar to some existing ve(3,3) projects.

Sure, have funding via the SNS, but better don’t use neurons as veTokens. While it is tempting to take an existing well-tested voting framework, they are completely different beasts and you probably will cause more bugs trying to marry them, than if writing a simple voting framework yourself from scratch. SNS will still control technical stuff, like canister upgrades and as a holder of IEX you can choose whether you want this or you want to control IEX pool distribution.

Introduce bribes, so the system will be alive and vibrant with different actors competing with each other to get dividends.

Give up on service fees redistribution - take it all to yourself and pay your guys good salaries. Remember, both LPs and Voters are in low-risk situations - they simply “lock” their funds, they don’t burn them or giving them away. They don’t lose anything. You’re just paying them a little extra so they don’t forget to keep their positions up to date and vote for stuff.

I think, this is the situation when you just have to take something that already has proven to work on other platforms and simply copy it on ours.

Have a nice day!

[ICPEx]

Thank you for your insightful response. Finally, someone is genuinely considering the development of IC DeFi! Otherwise, I would have thought IC DeFi would stagnate! We are very eager to discuss these issues with you.

1. Regarding the bribe issue:
   Clearly, the current SNS framework cannot directly implement a bribe mechanism, which is why we did not present it in the article. However, it is actually possible to achieve a simple bribe mechanism by walletizing the neuron accounts and adding a transparent display feature in the voting process. Of course, this would require collaboration from the DFINITY team.

2. Regarding the service fee issue:
   To clarify, the trading fee on ICPEx refers to the fee collected by LPs for providing liquidity in the respective pools, which will be directly reinvested into the pool. The ICPEx Service Fee refers to the 0.1% fee charged on each trade. In the design, this 0.1% service fee will be shared with Neuron Stakers. As you mentioned, this fee will involve multiple tokens, and this will inevitably require some selling actions to convert them into IEX. However, ICPEx will not sell the tokens all at once. We will set up a transparent algorithm to sell the tokens evenly over time. A healthy token ecosystem must be able to handle such fluctuations.

   In fact, there is another way to make the system more neutral. That is, instead of collecting service fees in the form of the respective trading pair tokens, we could opt to collect fees in ICP at the current market price and then buy back IEX. This method would not affect each project, but it would change the users’ behavior.

3. Regarding funding issues:
   This is a concern for every project team and community. Maintaining the stability of the token price depends not only on token buybacks and market-making logic, but also on the community’s confidence. The greatest feature of ve(3,3) is the creation of an upward spiral. Once a virtuous cycle is formed, everyone will increase their staking, and this has been proven in many ve(3,3) projects in other ecosystems. As for team buybacks, I would like to correct one point: this is actually treasury buybacks, because the funds are in the SNS treasury, not in the team’s pocket. Treasury buybacks serve as a mechanism to intervene in the token price, depending on the community’s confidence and decision-making. The community can initiate a buyback proposal when necessary.

   The funding limit is essentially a game of negotiation. The more funds in the treasury, the more stable the system will be, as it ensures adequate liquidity and buyback capacity. If this plan is approved, we will set a financing range to assess the community’s confidence in this mechanism.

4. Regarding team incentives:
   An important point is that the team would not want the portion of tokens they sell to severely harm the token’s economic system. A drastic decline in token price is detrimental to everyone. It is normal for the team to sell a portion of tokens periodically to maintain the project’s development and operations, and we only need to ensure transparency. The model we described in the article is actually the one that maximizes the benefits for the community. Of course, the reallocation of service fees you mentioned could give the team more confidence for continued development, and we will consider and optimize this mechanism.

5. Regarding the Rebase mechanism:
   Actually, in the model described, the Neuron’s Voting Power acts as a substitute for veTokens. A simple Rebase process would be to directly allocate the IEX dividends, based on voting power, to the Neuron Account. Of course, one shortcoming is that, under the current SNS framework, Voting Power is not tradable.

In conclusion, since SNS is already the most popular voting framework in the ICP ecosystem, we prefer to build the ve(3,3) model within the existing SNS framework. We also considered building a separate decision-making logic on SNS, similar to the structure of the House and Senate, but this might be overly complex. Using the existing SNS framework will inevitably require some trade-offs in functionality, but this is unavoidable. Overall, I believe this mechanism will be a significant milestone in promoting IC DeFi development. If no one else is as passionate about this proposal as you are, I don’t think IC DeFi has a future!

Thank you again for your response, and have a great day!