The Importance of Liqudity
The structure of KlimaDAO, which is modeled on OlympusDAO, stands to significantly improve the funding, ownership, and stability of the protocol.

Liquidity

Liquidity is often swept under the rug, and many people devalue the importance of it. At a high level, liquidity facilitates markets, allowing users to trade between two tokens. This is often seen in DeFi in AMMs (automatic market markers).
To incentivize liquidity, protocols reward those who do with their native token. As providers are exposed to impermanent loss (occurs on token price appreciation and depreciation), the hopes is that these rewards offset the losses. However, this provides yet another set of issues:
  1. 1.
    Temporary liquidity: The liquidity is mercenary, once the rewards leave, so does the liquidity. You've provided liquidity for the short term, but is not a permanent nor feasible solution.
  2. 2.
    No security: Since the liquidity is owned by users and not by the protocol, they are free to exit at any time. This means during times of turmoil, liquidity providers will leave in order not to suffer impermanent loss, when the protocol needs it the most.
  3. 3.
    Constant selling pressure: Since rewards are paid to the LP, they sell these rewards either to LP more, causing more emissions, or to another asset ,causing constant selling pressure to the token.
For long-term growth and stability of the protocol, an alternative to this is to ensure the protocol owns the liquidity instead. Since KlimaDAO launched, it has consistently owned >85% of the liquidity of the BCT/USDC and BCT/KLIMA pools. Achieved through the bonding mechanism, this has turned a reoccurring expense to a revenue generating asset.

The Game Theory (3, 3)

Given what we have learned above, we understand that the bonding-staking mechanisms are win-win for the protocol and the market participants. For the protocol, they deepen liquidity, grow the treasury and reduce volatility. They also enable the market participant to secure KLIMA at a discount, and get exposure to the protocol's growth by staking on the dApp. Selling is detrimental to the protocol.
The idea behind (3,3) is that if everyone cooperated in KlimaDAO, it would generate the greatest gain for everyone. Currently, there are three actions a user can take:
  • Staking (+2)
  • Bonding (+1)
  • Selling (-2)
Staking has the effect of pushing the price up +2. Selling has the effect of pushing the price down -2. The player who moves the price gets half of the benefit. Bonding has no price effect but provides a discount of 1.
Hence, the mechanics in play demonstrate how large-scale cooperation and alignment between market participants can be used to grow the long-term success of the protocol with maximum benefit for all.
The actions in play between two market participants can be illustrated as follows:
The system exemplified here, which was pioneered by OlympusDAO, delivers clarity, fairness, and ensures the long-term viability of the protocol. You can learn more about OlympusDAO in their docs.
This system enables KlimaDAO to build out a long-term sustainable protocol that incentivises the growth of the on-chain carbon market, and underpins the growth of this new carbon-backed economic paradigm. Ultimately, this is achieved through information sharing and aligning incentives between all participants.
We believe that this incentive structure, and the wide-scale co-ordination it enables, can be a game-changer in the fight against climate change, enabling DeFi participants to move the dial on climate action. To learn more, you can read our thought piece published in Bankless.
Last modified 3d ago