Simple Summary
Issuing equity - and incurring dilution - to pay for things that don’t generate growth is value destructive.
Issuing equity to stakeholders who sell the token is doubly negative because it causes sell pressure. The Alchemix treasury is made up almost exclusively of ALCX so sell pressure affects runway.
The DAO is currently issuing 109,000 ALCX per year to mercenary liquidity providers on Sushiswap (299 ALCX /day * 365).
ALCX emissions are the wrong way to incentivize liquidity providers when the token is trading at or near all-time lows. The negative impact of these emissions can be estimated a few different ways:
Expected price decline of 40% over 12 months as a result of sell pressure
Emissions generate no growth for Alchemix yet the cost of capital for ALCX is 44.5%, which implies material value destruction
7% dilution priced into the cost of capital lowers ALCX’s trading multiple to 9x from 13x, a 30% reduction
Liquidity providers should be adequately incentivized. Alchemix generates fees and has the ability to reward liquidity providers with revenue instead of dilutive equity. Bitfinex’s LEO token is a clear and successful precedent that can be imitated.
Motivation
The Alchemix treasury is made up of ALCX tokens. The value of Alchemix as a project, and the project’s runway, depends on the value of the ALCX token.
There is nothing the community or leadership can do about poor market conditions. We have to focus on what we can control. What the community and leadership control is capital allocation.
Problem
It is well documented that liquidity providers sell their native token rewards back into the pool they provide liquidity for (Pool 2 rewards). While having ALCX listed on DEXs is useful for price discovery, rewarding liquidity providers in ALCX can be overly costly in dilution and sell pressure.
One way to estimate the price impact of the sell pressure caused by liquidity providers is slippage. Slippage is calculated as the price movement of an asset within liquidity pools as a result of buy or sell volume.
1inch is a DEX aggregator. It aggregates liquidity across all major DEXs and routes trades through the best possible routes to minimize slippage. 1inch can be used to estimate the overall market slippage caused by liquidity emissions being sold into the market.
[https://app.1inch.io/#/1/unified/swap/ALCX/ETH](https://)
If we attempt to sell 109k of ALCX via 1inch, it would cause a 40% price reduction given current market liquidity across DEXs.
One could argue that the slippage from selling 109k of ALCX in a single transaction is not representative of sell pressure: there could be “buy” demand that would step in to buy ALCX as the price moved lower. While that makes sense in theory, the 95%+ decline since all-time-highs speaks to how little “buy” support remains in the market.
Another way to evaluate the cost of using native tokens is the cost of capital. We observe from Token Terminal that ALCX currently trades at 9x. Using very crude valuation math:
(1 + g) / (r - g) = 9x, where r = discount rate and g = growth
Assume g = 30% (crypto is high growth)
(1 + g) = 1 + 30% = 1.3
Manipulating the first equation above: (r - g) = (1 + g) / 9x
(1 + g) / 9x = 1.3 / 9x = 14.5% = (r - g)
given g = 30%, then r = 44.5%
The cost of capital for ALCX, assuming ALCX achieves market growth, is 44.5%. Unless ALCX tokens are issued to finance opportunities that generate >44.5% return for the DAO, then issuing ALCX is value destructive.
Finally, we observe that 109k of emissions over 1.5M ALCX outstanding is 7% dilution. The market is pricing in an additional 14.5% cost of capital over and above the market growth rate (44.5% - 30% = 14.5%). In other words, the market is aware of, and accounting for, this dilution in the ALCX discount rate.
Moving forward
The root cause is that the ALCX token is the only tool the Alchemix DAO has to reward stakeholders. This is problematic for the DAO in two ways: (i) the use cases for ALCX issuances do not generate >44.5% growth and are therefore value destructive and (ii) not all stakeholders who receive ALCX tokens are long-term believers in the project, which leads to sell pressure.
The solution is to reward short-term stakeholders and pay for expenses with a non-dilutive token.
A great example of a non-dilutive token is the Bitfinex LEO token issued in 2019. The LEO token has no voting power on the treasury (i.e., it was not an equity claim). Instead, Bitfinex committed to using 27% of fee revenue to repurchase + burn LEO tokens from the market until all of the LEO tokens are gone. In effect, Bitfinex created an ERC-20 token that derives its value from protocol revenue instead of being an equity claim on the treasury.
The advantage of this structure is that it creates a clear alternative to equity tokens:
1) LEO tokens are simply non-dilutive revenue tokens. Using revenue tokens to pay for things represents a much cheaper cost of capital than equity
2) Any sell pressure on the non-dilutive revenue token does not impact the native token. Liquidity Providers can receive the same level of compensation, dump the revenue tokens into the market for yield, and the native token doesn’t experience any sell pressure or dilution.
Alchemix pays 109k ALCX/yr * $20 = $2.2M worth of liquidity rewards/yr. Alchemix also generates ~$6MM in fees. The DAO could replace Sushiswap liquidity rewards with a similar non-dilutive revenue token.
Partnership opportunity: Cinch Protocol
We are putting forward our platform, Cinch Protocol, as a partner in setting up this structure. Our app does all of the legwork in implementing the revenue-share logic and spinning up a liquidity pool so that individual projects don’t have to. Our tooling is designed such that a non-technical team member can implement this structure in a matter of minutes.
We are currently working with industry leading DeFi protocols looking to protect their native token holders and grow their native token price.
Quantifiable benefits
If Alchemix could replace all current Sushiswap liquidity rewards with a non-dilutive revenue token, the ALCX price could be 40% higher in the next 12 months than if the sell pressure continues.
Said differently, issuing a non-dilutive revenue token to compensate liquidity providers would remove 7% of dilution. Assuming this shrinks the ALCX discount rate by 7%, this is how the ALCX price should react:
(44.5% - 7%) = 37.5%
(1+g) / (r-g) → (1.3) / (37.5%-30%) = 1.3 / 0.075 = 13x multiple (vs. current multiple of 9x).
13x / 9x = 1.45x = 45% ALCX price increase to ~$29/ALCX (vs. current price of $20/ALCX).
Summary & next steps
Cinch Protocol is currently helping a handful of DAOs leverage their revenue instead of their native tokens to grow.
Issuing equity to pay for expenses that don’t generate growth is value destructive for long-term ALCX holders. This can be evaluated by assessing the cost of capital of ALCX or by estimating the sell pressure that is likely to result from token issuances to short-term holders. Further, the market prices in expected dilution, which affects ALCX’s trading multiple and token price.
The solution is to use a different type of token - a revenue token - to pay for things that do not generate growth. Using a revenue token protects long-term ALCX holders from harmful dilution and sell pressure.
We submit to the community that this kind of structure can be implemented gradually and that it can be done with almost no disruption to existing operations. Our app makes it extremely easy - it would not require any developer resources and would cost $0 from the treasury.
We look forward to answering questions or providing further details. Most importantly we are interested in the community's genuine feedback! Please don't hesitate to let us know what you think.
Thanks,
Habs4lyfe (Max LS)
