Boosted Yield

Liquidity Notes are yield-bearing primitives because they are collateralized by Liquidity Provider (LP) tokens. These LP tokens generate yield in the form of trading fees from the underlying liquidity pool. The handling of these trading fees can be configured in two ways:

1. Automatic Accrual to the LP Position (Uniswap V2 Style)

   • In this configuration, trading fees are automatically reinvested into the LP position. The value of the LP tokens increases over time as fees are accrued, enhancing the overall yield of the Liquidity Notes without requiring manual intervention.

2. Manual Claiming of Trading Fees (Uniswap V3 Style)

   • Alternatively, trading fees are set aside separately from the LP position. Holders of Liquidity Notes can manually claim these accumulated fees at their discretion. This approach provides more control over the timing of fee collection but requires active management by the investor.

Configuring Yield Distribution between Project and Investor

Cryptocurrency projects have the flexibility to determine how much of the yield from Liquidity Notes is allocated to note holders. This is achieved by configuring the percentage of trading fees earned by the underlying LP collateral that is passed on to the Liquidity Note holders.

Example Scenario

Consider the following example to illustrate how yield distribution can be configured:

1. Initial Investment and Collateral Formation

   • User Investment: A user purchases a Liquidity Note for 100 USDC.

   • LP Collateral Composition: The Liquidity Note is backed by an LP position valued at 200 USDC, consisting of:

     • 100 USDC from the user's purchase.

     • 100 USDC worth of TOKEN contributed by the project's treasury.

2. Default Yield Configuration

   • Yield Allocation: The default setting allocates trading fees based on 100% of the Liquidity Note's initial value (i.e., the user's 100 USDC investment).

   • Distribution Outcome:

     • The user receives trading fees corresponding to 50% of the total LP collateral (their proportion of the investment).

     • The project retains the remaining 50% of the trading fees, corresponding to the TOKEN it contributed.

3. Alternative Yield Configuration

   • Enhanced Yield Allocation: The project can configure the Liquidity Note to provide up to 200% of the yield based on the Liquidity Note's initial value.

   • Distribution Outcome:

     • The user receives trading fees from the entire 200 USDC LP collateral.

     • This means the user gains 100% of the trading fees generated by the LP position.

     • The project does not retain any portion of the trading fees in this configuration.

Considerations for Determining the Level of Yield Distribution in a Liquidity Note

When configuring a Liquidity Note, one of the essential parameters to establish is the level of yield distribution. This determines how the trading fees generated by the underlying Liquidity Provider (LP) collateral are allocated between the Liquidity Note holders and the project. Setting an appropriate yield distribution level is crucial for balancing investor returns, project sustainability, and overall market attractiveness.

Key Considerations

1. Investor Expectations and Incentives

   • Assessment: Understand what investors seek in terms of returns and risk mitigation.

   • Impact: Competitive yield distributions can make Liquidity Notes more attractive, increasing demand and participation.

   • Example: If comparable liquidity notes in the market offer around 120% yield distribution, setting a similar or slightly higher percentage (e.g., 125%) can enhance the Liquidity Note’s appeal.

2. Yield Sustainability and LP Collateral Performance

   • Assessment: Evaluate the historical and projected performance of the LP collateral in generating trading fees.

   • Impact: Ensuring that the yield distribution level is sustainable based on the LP collateral’s performance prevents overcommitment and maintains project viability.

   • Example: If the LP collateral consistently generates an average of 20% annual yield, distributing 120% (24% APY) to investors ensures that the project retains 16% APY for its obligations and reserves.

3. Balancing Downside Protection, Upside Boost and Yield Distribution

   • Assessment: Determine how yield distribution interacts with downside protection and yield boost mechanisms.

   • Impact: Higher yield distributions may necessitate downward adjustments in downside protection and yield boost levels to maintain financial balance and project obligations.

   • Example: Offering a high yield distribution of 200% might require the project to set a moderate downside protection level (e.g., 20%) to ensure that both investor returns and protection are adequately funded.

4. Market Conditions and Competitive Landscape

   • Assessment: Analyze current market trends, competitor offerings, and overall demand for liquidity instruments.

   • Impact: Aligning yield distribution levels with market standards ensures competitiveness and relevance.

   • Example: In a bullish market with high investor interest, a project might increase yield distribution to capture more capital, whereas in a bearish or uncertain market, maintaining a stable or slightly lower distribution can preserve investor confidence without overextending obligations.

5. Regulatory and Compliance Considerations

   • Assessment: Ensure that yield distribution practices comply with relevant financial regulations and standards.

   • Impact: Adhering to regulatory requirements avoids legal complications and fosters trust among investors.

   • Example: Some jurisdictions may have caps on yield distributions or specific disclosure requirements, influencing the maximum feasible distribution level.