What’s Protocol Monetary Trade Policy, and Why Is it Such a Big Deal?
June 30 2022 - 9:55AM
NEWSBTC
Innovations that push boundaries tend to generate buzz before
they’re fully adopted by the broader DeFi community. Protocol
Monetary Trade Policy is the newest one on the horizon. It’s
already considered by some as the evolution of liquidity mining,
despite being relatively new in the space. The policy’s proponents
say it will greatly benefit the DeFi ecosystem, but it’s worth
examining exactly what Protocol Monetary Trade Policy is, how it
compares to traditional DeFi economics, and whether it truly has
the potential to revolutionize the crypto-economic space. What is
Protocol Monetary Trade Policy? Protocol Monetary Trade Policy
(PMTP) is a set of monetary policies that use a cryptocurrency
protocol’s influence over currency trade or transfers to support
the health of the protocol and its core token(s). In theory,
it may eventually eliminate the need for inflation. The policy was
invented by a team of crypto economists at Sifchain. One of the
main goals of Protocol Monetary Trade Policies is to help attract
external liquidity while increasing total value locked (TVL). It
does this by incentivizing a cryptocurrency token such as ROWAN,
creating an attractive option to earn rewards in. In turn, this
helps to drive external demand to pool assets and encourage the
purchase and staking/holding of the specified token. “Sifchain sees
Protocol Monetary Trade Policy as an innovative suite of tools that
can provide flexible & powerful utility alongside other
features, like margin trading. These policies would allow DAO
governance to decide on how to move these various monetary policy
levers, which would provide immense value to both traders and
liquidity providers. So far, Sifchain has introduced one of these
policies in pool Ratio Shifting. In the future, others can be
introduced, but ultimately, the future of the protocol and how
these various levers are enabled/disabled/used is in the hands of
our community through the DAO voting structure.” Says Sifchain’s
Head of Business Development, Casey Arrington. But how exactly does
Protocol Monetary Trade Policy differentiate itself from other
economic models? How Protocol Monetary Trade Policy differs from
traditional DeFi economics A typical decentralized exchange (DEX)
has at least one liquidity pool that allows users to swap crypto
assets. It uses an automated market maker (AMM) algorithm to
maintain fair market value for exchanging token pairs. Let’s take a
liquidity pool with tokens A and B. The pool starts with a 50-50
ratio in value for both assets. This ratio needs to be maintained
at all times. Thus, as trading occurs and the proportion of tokens
in the pool changes, arbitrage opportunities are created, allowing
traders to capitalize on the price discrepancy. For example, as
more people swap asset A for B, there will be more of A in the pool
and less of B. This pushes the value of A down, reducing its
purchasing power relative to B. On the other hand, the value of B
goes up, increasing its purchasing power relative to A. Protocol
Monetary Trade Policy uses real-world economic fiscal policy models
at the protocol level of a token to help mitigate the pool
imbalances that inevitably arise as users swap tokens. These
policies can be used as tools to incentivize and encourage user
behavior to help protect the health and price action of a liquidity
pool. One common policy in most DeFi protocols is using inflation,
where the protocol mints new tokens to give to users based on
certain activities. With pool ratio shifting (and other monetary
policy mechanisms), instead of minting new tokens, protocols make
an alternative adjustment in other economic parameters to encourage
certain behaviors. The adjustments are decided by members of the
DAO. For example, governance tracks multiple metrics, like external
liquidity, before making any decisions. If external liquidity is
low, they will propose a policy with the goal to draw in external
liquidity. The DAO then votes to approve the policy. Once
implemented, the purchasing power adjustment goes into effect.
Using a ROWAN (Sifchain’s token) USDT trading pair as an example,
if pool ratio shifting from Protocol Monetary Trade Policy is set
for a 2% purchasing power increase per day: One ROWAN buys 1 USDT
in block 1 One ROWAN buys 1.00005787037 USDT in block 2 One ROWAN
buys 1.00011574074 USDT in block 3 This example shows how the pool
ratio shifting tool from Protocol Monetary Trade Policy makes very
subtle adjustments to the purchasing power of a token over a period
of time. Since you can use fewer assets to buy more, the adjusted
assets become more useful than they would have been without the
Protocol Monetary Trade Policy. Sifchain states that, unlike
traditional liquidity pools where the cryptocurrencies influence
monetary policy primarily through inflationary rewards, Protocol
Monetary Trade Policy aims to influence the number of opportunities
a token holder has to trade their existing quantity at a specified
ratio. It is important to mention that Protocol Monetary Trade
Policy will not fix the price of a token at a certain level. The
price will still change depending on the balance of the liquidity
pool. Additionally, the aim of these policies is never to restrict
the trade of a token; holders are free to trade a token anywhere,
on any exchange. What kind of advantages does it offer to
protocols? One of the biggest advantages of Protocol Monetary Trade
Policies is that it helps make it possible to reduce inflation. By
increasing the value of a token on an exchange, the policy can help
fewer tokens to have the same purchasing power. Protocol Monetary
Trade Policy can also be a helpful tool for attracting liquidity.
The subtle increments to the purchasing power of the token make it
more valuable to accumulate. Furthermore, there is an increase in
the rewards earned from providing liquidity and staking/delegation.
This encourages people to pool external liquidity with that
particular token. Because these policies in DAOs must be voted in
by community members before they can be implemented, users can
directly influence their returns. Plus, they get the opportunity to
be part of an evolution in microeconomics. Thus, new users and
projects have even more reasons to add their liquidity to the
protocol. The Protocol Monetary Trade Policy also has the potential
to start a TVL snowball reaction. As the price of a token
increases, its TVL increases, further increasing the price, which
then increases the TVL, and so on. This cycle draws liquidity
providers, creating more liquidity in the protocol. Note that
members of a DEX or DAO don’t have to do anything to benefit from
Protocol Monetary Trade Policy, even though they are encouraged to
participate in governance. The policies are automatic. So, as long
as you have assets in the pool, you’ll still enjoy the benefits.
Sifchain example Sifchain recently incorporated the pool ratio
shifting tool from Protocol Monetary Trade Policy after their DAO
vote passed the policy, making them the first protocol to bring
these real-world monetary policy tools to the protocol level.
Members of the community were greatly impressed by its potential
benefits and were excited to be a pioneer of this new monetary
policy. Sifchain saw the vision of the policy and one SifDAO member
noted that, “Protocol Monetary Trade Policy is like early nuclear
research. It can be incredibly strong; we’re just freaking out over
the fallout. But this thing can absolutely win the market for us.”
However, things didn’t go exactly as expected. To protect value
gains in Rowan and the liquidity on Sifchain, Ratio Shifting was
intended to eventually be paired with DEX Liquidity Protection,
another key feature in PMTP. Unfortunately, Sifchain didn’t
expect a major sell-off to occur before DEX Liquidity Protection
was deployed. After experiencing some troubles during a bear
market, members of the DAO voted for a return to their original
policy of balanced pools. It was also noticed that these policies
could best be implemented as an add-on to other features. For
example, purchasing power adjustments can be extremely interesting
when coupled with the ability to take out margin positions. Margin
traders looking for any type of signal to help with their positions
would likely welcome purchasing power adjustments as an additional
helpful lever. Still, Sifchain believes that these policies have
the potential to change DeFi economics for the better. These
policies are especially effective when looked at holistically in a
way that can complement each other and handle any type of market.
So with some minor finetuning, these policies are likely to be
beneficial in the future. A growing movement Protocol Monetary
Trade Policy is an exciting innovation in the crypto-economic
space. Currently, Sifchain is spending a lot of time on community
education initiatives. For anything to be successful, including any
monetary policy, the community needs to fully understand its power
and limitations. Sifchain has learned this with the previous launch
of Protocol Monetary Trade Policy. The team is now ensuring that
this lesson is carried forward with core features that are top
priorities for its’ roadmap, such as margin trading and Omni-EVM.
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