Proposal: Introduce Liquidity Incentives for Aave v2

Background:

Aave has grown from $0 to $5 billion+ in total liquidity in just over a year. This growth has impressively been achieved without any liquidity incentives.

In fall 2020, Aave V2 was launched on mainnet and the LEND token was migrated to the new AAVE token. 3MM of the 16MM AAVE token supply has been allocated to the Aave Ecosystem Reserve, managing the distribution of safety and ecosystem incentives. In September 2020, AIP-1 passed, kickstarting the Safety Module and distributing 400 AAVE per day to stakers. In January 2021, AIP-7 passed, activating AAVE slashing and increasing the safety incentives to 550 AAVE per day. 20% of the fully-diluted AAVE supply is currently staked.

As described in the Aavenomics paper, the Aave community can vote to distribute liquidity incentives from the Ecosystem Reserve.

Proposal:

The intent of this RFC is to open up the discussion among the community to explore a liquidity mining (LM) program that optimizes for the long term growth of Aave. We believe that a well designed LM program can accomplish the following (as discussed in more detail below):

  • Grow lending and borrowing activity in targeted markets
  • Further decentralize/expand the AAVE token holder base
  • Incentivize v1 to v2 migration
  • Increase long-term pools of capital via stkAAVE distribution

Below is a rough sketch of ideas to consider. We invite the community to comment and vote below on the general idea of a LM program.

Liquidity Mining Benefits:

Grow lending and borrowing activity: With almost every major DeFi protocol launching a liquidity mining program, we believe it would be advantageous for Aave to utilize part of the Ecosystem Reserve to drive lending and borrowing activity across markets. Distributing AAVE to borrowers and lenders acts as an added incentive to attract more capital. The distribution can become more targeted over time. For example, certain markets may need more AAVE than others based on liquidity, utilization, and maturity of the market.

Broader distribution and protocol decentralization: Rewarding AAVE to users of the protocol improves the distribution of the AAVE token. This gets AAVE into the hands of more users, further decentralizing the protocol.

Deprecating Aave v1: Due to high gas fees and a lack of incentive to migrate, Aave v1 still contains approximately 60% of the value locked in the broader Aave protocol. By introducing liquidity mining rewards only provided on Aave v2, liquidity providers and borrowers will naturally migrate toward the optimized version. Declining liquidity on Aave v1 will facilitate a gradual deprecation of this iteration of the protocol, allowing more development activity to be directed at Aave v2.

Liquidity Mining Design Commentary:

We would like to open up the discussion among the community to explore introducing liquidity mining incentives:

Distribution: We (ParaFi) propose a distribution of 550 Staked AAVE (stkAAVE) per day split 50-50 between lenders (275) and borrowers (275). We have considered various splits but, for now, have decided to go with an equal split for this pilot liquidity mining program.

This distribution is in line with the daily staking rewards and equates to 200,750 stkAAVE distributed per year or $103MM ($513.2/AAVE) in annualized rewards to borrowers/lenders at current prices (excluding any additional staking yield). From a supply perspective, this distribution results in only 1.25% of the fully diluted AAVE supply released each year. From a dollar value and token percentage standpoint, 550 stkAAVE/day remains significantly lower than comparable DeFi platforms. We believe the community will increase the LP distribution over time to become in line with other LM programs.

However, this allows the community to appropriately scale the distribution based on market dynamics and user activity. We have seen new DeFi protocols overpay for liquidity in the short-run and underpay for liquidity in the long-run. A relatively lower distribution to start leaves the ecosystem reserve with enough resources to scale up/down the allocation to users. If 550 stkAAVE/day is low based on liquidity and utilization, the community can vote to increase the distribution. A healthy portion of the reserve still remains for other critical areas (i.e rewarding integrations, grants, audits, etc).

Targeted Markets:
Given the number of markets on Aave, we see value in rewarding a handful of markets to start through a targeted distribution. The goal of this distribution is to increase borrow volume, pool utilization, and overall fees generated for the protocol. Over time, the community can vote to reward more markets.

For the initial distribution, we propose the following markets should be included:

  1. USDC
  2. USDT
  3. DAI
  4. GUSD
  5. sUSD
  6. TUSD
  7. ETH
  8. WBTC

Pro-Rata Distribution and stkAAVE Rewards

550 Staked AAVE (stkAAVE) per day will be allocated pro-rata across supported markets based on the dollar value of the borrowing activity in the underlying market.

This distribution strategy rewards markets based on borrow demand. Markets with higher dollar value borrowed receive a higher share of the daily stkAAVE rewards.

stkAAVE will be rewarded instead of AAVE to align long-term incentives, disincentivize speculative farmers, and allow users to earn an underlying yield on top of the AAVE they earn. This helps align LPs by giving them more governance weight upfront and secure the protocol by increasing the amount of AAVE staked in the Safety Module. LPs then immediately earn a staking yield on their vested AAVE.

stkAAVE requires a 10 day cooldown period. The cooldown period must be started before LPs can unstake their AAVE. After the cooldown period, users have a 2 day window to unstake. By distributing rewards in stkAAVE, borrowers and lenders are immediately aligned with the protocol, increasing the security stake while earning a yield on their AAVE rewards.

This cooldown period indirectly serves as a vesting component for LP rewards. In Compound’s liquidity mining program, Gauntlet stated a “large fraction of COMP holders are selling all of their earnings and not staying long-term holders.” We have seen this dynamic take place in a number of DeFi protocols post-launch. By implementing stkAAVE rewards, we naturally mitigate this suboptimal outcome. If need be, the community can vote to implement a vesting component for stkAAVE (i.e LPs receive ½ stkAAVE upfront, receive ½ stkAAVE in 6 months).

There is room to increase the daily AAVE distribution based on the number of markets, liquidity levels, and utilization. Over time, the LP rewards can be used to bootstrap liquidity in new markets and encourage new assets to be onboarded.

Any distribution schedule can be reviewed on a quarterly basis.

Projected AAVE LP Rewards (Annualized)

We welcome feedback from the community on this proposal.

Poll:

Should Aave activate rewards for borrowers and lenders?
  • Yes
  • No

0 voters


3 Likes

I like this idea, but I want to wait for smarter people to chime in before I vote! Sounds very interesting at first.

My only concern would be changing what we’ve been doing that seems to have been relatively effective. (Not a very Defi mindset though, I’ll admit.)

1 Like

I’m wondering how this would run smoothly with flash loans in the mix…?

Growing activity on v2 seems most natural by supporting the native asset of communities like Synthetix, Curve & Balancer etc.

A few ideas to incentivise v2 migration:

  1. Airdrop
  2. Layer 2 integration
  3. Approve the $xSushi as collateral proposal
  4. Add v2 aToken pools to SushiSwap for $SUSHI farming
4 Likes

Very well-thought out distribution schema, especially the stkAAVE disincentivizing dump-on-sight.

This will help incentivize AAVEv1 → AAVEv2 migration.

This will also augment liquidity and stabilize rates on AAVE.

1 Like

Can the ecosystem reserve really afford to give away 1100 aave a day in staking and 550 a day in liquidity mining? That’s 602k aave annualized. At this rate, we’ll run out of the ecosystem reserve in 5-6 years. Wouldn’t it be better to lower staking + liquidity mining incentives and not give it all away in a bull run?

4 Likes

I do not agree with this proposal. It is a suboptimal allocation of the ecosystem reserve.

  1. Grow lending & borrowing activity: Lending/Borrowing activity is already happening naturally and the fluctuating interest rate is already subsidizing LP’s that are being overutilized.

  2. Broader distribution and protocol decentralization: Unsure about this, big players are going to be receiving the majority of the rewards.

  3. Deprecating Aave V1: In my opinion, it is already slowly being deprecated and the increased gas fees are already an incentive to migrate.

1 Like

I think there are already incentives built in that support our goals.

We need to maintain the ecosystem reserve to support Aave during bear markets not frivolously distribute it during bull markets in order to hasten issues that seem to be correcting naturally.

5 Likes
  1. Great idea. Long due

  2. 50/50 split is wrong. Didnt Compound mining launch teach you anything? This will break the aave market dynamics.

  3. HAVE TO add a retrospective reward for v1 and v2 lenders and borrowers (with time-weighted multiple). Can be vested over 12 months, similar to Curve.

1 Like

Hi,

I have to admit that this is the very first time I am not happy with a proposal. The problem we all saw with LM was a quick shift from one into another protocol like we saw last summer. The result was that the protocol skyrocketed on TVL but after a while the price crashed extremely fast.
If you still want LM, then there should be some more security/ features implemented to counter this kind of action.
For example the only thing, stopping people from doing so and taking their liquidity and dump their farmed token is the cool down period. But what if something else would be implemented? Like a multiplier. Meaning if someone stays longer in the pool, he will get more token based on the multiplier. So instead of 10 days CD, it could be 90 , 180 and 365 days where each mark would increase the multiplier.

Another option would be if people leave the pool quite fast a burning could happen. For example you have to stay some time in the pool to get no burning at all. And this could be set in stages. 10 days = 20% burning, 30 days = 10% burning, 60 days = no burning at all.

I think you get the point. It is important to inboard new LP to stay longterm and not just get in with huge amounts, farm everything, dump it and leave.

10 Likes

Hi,

I’m a big fan of incentive for migrating from v1 to v2, good job with that!

This being a few questions/doubt arise, I preferred the rewards to decrease over time (in the style of a 1/exp(x)) to speed up the migration in the short term but keep an incentive longer.

Secondly could you explain your markets choice? For example why GUSD who is not in V1 so not relevant for the migration incentive and not BUSD who have a pretty good supply in v1? Why not LINK (which is huge in v1) or YFI or SNX? I’d rather attract the big markets first to stay in the logic of accelerating migration.

Thanks for the proposal and keep up the good works!

Regards

1 Like

I have to wonder if perhaps some of the rewards should be allocated to the $AAVE tokenholders who stake stake their tokens to secure the network. I realize that these tokenholders already get a modest reward, but at 6% it isn’t much at all.

3 Likes

I questioned this proposal on the face of the title however after reading through it I am fully supportive of it.

I believe the reward of stkAAVE as a crucial component to the success of this proposal aligning stakeholders over the long term success and growth of the project. The 1.25% supply sounds sensible given it’s in line with current staking rewards.

Alex B

1 Like

Good idea but needs to exclude WTBC / ETH
Only incentivize the USD deposits and weight by borrow demand.
Also wouldn’t incent borrows. Just incent USD lenders.

5 Likes

I’m strongly against the proposal for a few reasons:

  1. It doesn’t make much sense to incentivise migration → this will set a bad precedent where every time a new version of the protocol comes up, LPs will expect some sort of incentive before they migrate. Rather, the new version should be “so good” such that liquidity providers will want to migrate to take advantage of the new protocol.

  2. stAAVE distribution does not really help incentivize long-term holding as 10 days is way too short and cannot possibly be considered long term in anyway. SNX escrow period is 1 year, and Sushi swap liquidity mining vested 2/3rds of the rewards after 3 months.

  3. Running liquidity mining programs after the protocol has been live and successful for such a long-time feels like a step backwards, especially if the plan is to incentivise the current existing pools which are working along just fine. There is a reason why uniswap themselves decided to stop their liquidity mining program, and yet their growth is coming along just fine.

I think it will make more sense for the protocol to focus on bridging to real-world assets, and perhaps giving out AAVE to incentivise people to build out peripheral protocols that connect AAVE to real-world assets.

As an aside, a more effective liquidity mining programme would to just incentivise the demand side (so we can give out half the amount of tokens). Incentivise demand will push up interest rates sky high, and supply will follow. This is way more effective than compounds liquidity mining programme. If we were to incentivise demand and supply, that would kind of be like an Curve giving out governance tokens to people who make swaps on the protocol.

11 Likes

Thank you Anjan for putting the proposal forward; a few thoughts:

1.3% of annualized inflation seems generally reasonable to us as a CAC to incentivize longer-term LTV boost to Aave.

  • We generally feel that crypto lending (WBTC, ETH) and stablecoin borrowing (USD) are the most natural demand today (and likely in the future) and will occur naturally without any incentives (given a host of reasons – borrowing a non-appreciating asset to maximize returns via leverage and/or farming, delay selling for tax purposes, etc)

  • On the other hand, crypto borrowing is more opportunistic (mostly for farming) and stablecoin lending today is typically unnatural for crypto-natives. To wit, the latter would forgo potentially sizable crypto returns – and such a group may pertain mostly to (a) crypto credit funds and/or (b) non-crypto-natives looking for high-yield.

  • Therefore, we tend to believe that more aggressively incentivizing stablecoin lending would be the “most bang for the buck” to maximize LTV / CAC for Aave’s inflation:
    — lowest stablecoin borrow naturally attracts borrowers
    — similarly, lowest borrow naturally attrends crypto collateral lenders
    — with more crypto collateral lenders, crypto borrowing may come at lower rate which attracts demand upon opportunistic farming opportunities.
    — all such measures would ensure the TVL : borrowed ratio stays high and efficient.

  • Therefore, as an idea, we suggest Aave to consider for example directing most if not all of the 550 AAVE token towards stablecoin lending only across [USDC, USDT, DAI, GUSD], with opportunistic allocation too secondary stables such as [sUSD, TUSD, UST, etc]. The allocation should also be negotiated heavily with the stablecoin-issuer – with the anticipation of more aggressive assistance / integration / synergistic steps. For instance, a big allocation of AAVE to GUSD lender would almost certainly help adoption of GUSD – Aave should thereby ask for priviledged treatment across Gemini #DeFi business development efforts.

  • We generally support longer lock-up of rewards and thereby support a vesting similar to 1/2 10 day + 1/2 6 month. We also feel like an option of accelerated vest should be available for (a) paying a say 10% cost to vest-all, the 10% is burned, and/or (b) tailor vesting schedule to the amount of TVL / borrowing provided.

4 Likes

Hey everybody, i’m usually a lurker here on the forum but i believe this topic is really important so i decided to jump in.

although i’m not against liquidity mining, these numbers look more like an attempt to pump the tvl/bring fake borrowing volume rather than cultivating actual organic growth.
First of all i would remove from the list TUSD, GUSD, SUSD, BUSD, WBTC and ETH. ETH/WBTC borrowing is a limited usecase and incentivizing it would only bring fake outstanding debt,
which might be good to bring more fees but not now with a migration in process.
GUSD, SUSD, BUSD and TUSD have limited use in defi (even though sUSD is mostly used on synthetix), their total supply is rater low and it would essentially waste the emission to reward relatively unproductive assets.

I think the protocol would be better off rewarding only DAI/USDT/USDC for the first quarter, for the following reasons:

  1. there is currently 370M of outstanding debt on Aave V1 on DAI, USDC and USDT. Borrowers on V1 are reluctant to migrate because liquidity on V2 is taken very quicky, borrow rates are high and the migration is damn expensive (i’m a borrower on V1 myself and i need to spend 700$ to migrate, with the current V2 borrowing rates it’s just not worth it). At the same time V1 borrowers are experiencing high gas costs and cannot leverage the new V2 features, which bring bad user experience.

  2. the remaining outstanding debt is mostly ETH, WBTC and SNX. V2 can easily cover the needs for these borrowers to migrate, since there is plenty of ETH/WBTC liquidity and rates are even better in V2 right now.

  3. Since as you are saying in the proposal Aave can’t compete with compound/other protocols in terms of liquidity mining APY, the Liquidity mining program needs to be as targeted as possible
    to facilitate real growth of the ecosystem and onboard everyone on the latest iteration of the protocol.

For that reason if we bump the emission a little bit to 650 AAVE/day splitted across 3 currencies (DAI, USDC, USDT) instead 9 and with a ratio of 80% LPs/20% borrowing, there would be the following situation:

Let’s imagine a price of 400$/AAVE, which is a fair bit below the current market price but it’s closer to the average of the last two weeks;

image

Let’s consider DAI:

With your proposal, LPs would get 30.5 AAVE/day. At 400$/AAVE, that’s 4.453M year. Considering the current V2 reserve size of 74M, that’s 6% APY. Compound DAI APY is 5.9% APY. I fail to see how this emission will attract any meaningful additional liquidity, especially considering there is the need of 63M more DAI just to cover the debt on v1 for the migration. The eventual leverage doesn’t help either, because people leveraging will just drive the supply/borrowing APY up, which might attract more liquidity yes, but at the same time will keep the borrowing rates high, disincentivizing organic borrowers (ie borrowers that borrow on Aave to use the funds elsewhere). This is exactly what’s happening on Compound: People might think that for real borrowers it’s always better to borrow on Compound because you get paid for it, but that’s actually false: right now for example there is a 6% subsidy in COMP, but the borrowing rate is 13%: Borrowers that don’t leverage pay 7%, and that’s MORE than Aave V2 WITHOUT borrowing incentives. This is the result of the crazy leveraging happening in their protocol. Moreover, entities that can’t leverage (think for example of liquidity coming from curve pools) would have little to no reason to move to V2.

With my proposal, DAI LPs would get 31.6M$ in AAVE a year. With the 74M currently in V2, that’s nearly 50% APY. If we imagine that the APY settles around the one of compound, thats 10 times more liquidity than what’s available in V2 right now. Aave V2 would have the cheapest DAI lending rates on the market by far, which would drive up organic growth. At the same time, borrowers will get 43 AAVE/day, which is 6.3M/year, so on 120M outstanding debt for example the reward APY from borrowing would still be 5%, lower than compound but coupled with the high stablecoin liquidity, it means that organic borrowers actually earn from borrowing (as i mentioned before, the same can’t be said for compound unless you leverage: an “organic” borrower on compound right now still has to pay around 7% a year, that is the difference between the subsidized 6% and the borrowing APY of 13%)

Same reasoning can be of course applied to USDC and USDT. These three currently drive the growth of the defi space, so that’s what needs to be incentivized the most, i have no doubt about it.

That would be, of course, for the first quarter - if it does not work, can be changed and/or other assets can be added.

So that’s it - you have my opinion, the community can do whatever they want with it. I really hope we take the path of incentivizing organic growth rather than bringing useless farming volume - i really want to migrate to v2 :)

7 Likes

@Anjan-ParaFi you explained very well the chosen emission scheme and the usage of stkAAVE (which i find fascinating) but there is no explanation on the distribution percentages or the asset choices, can you provide your rationale?

I voted NO on the current proposal, but i may change my vote if i’m convinced by your arguments or the proposal gets updated to be more targeted towards organic growth

1 Like

Not reallt relevant proposition as we don’t need incentive to grow the network the tech speaks by itself !
The incentive should only be regarding the safety module or nothing !!
You want tokenomics like curve ? It will just hurt the tokenomics without real affect the network effect wich is already there growing and recognize.
Good try by the way

4 Likes

Defragmenting liquidity is the important part - a bit of carrot to drive v1 users to v2 sooner rather than later. Perhaps that’s what should be specifically subsidized, rather than a blanket incentive that will be mostly wasted on mercenary capital.

2 Likes

I feel these mess with the market in unforseeable ways. Much better to use Aave to provide incentives to backstop the protocol imo. And use it to reward innovation and other protocols piping into Aave ecosystem.
Howw do you stop the problem where people stake and borrow recursively?

2 Likes