[This blog post is part of CryptoExponentials DeFi Educational Series]. Is crypto market facing DeFi liquidity crunch? Answer is a profound YES. So, what is the solution? Let us explore…

There are over twenty thousand crypto projects on the market today. All of them, with the exception of the top 1% need to manage liquidity for their coins. (Only the largest projects have enough trading volume to naturally have deep order books, which means they don’t have to worry about liquidity.)

Liquidity means market depth, so traders can buy and sell a coin without huge price swings. The larger a trade and the larger the overall trading volume, the more liquidity is required.

Strong liquidity creates market stability, fairer prices, reliable markets, and more seamless transactions. Markets cannot exist without liquidity.

If the normal internet is the “internet of data”, the Blockchain Ecosystem is the “internet of value”. And instead of data flow, you have value flow.

Liquidity is of paramount importance for value flow.

The “internet of data” went from slow dial-up connections to high-speed broadband, which enabled much greater data flow.

Liquidity is the bandwidth of the “internet of value”.

And right now, liquidity is constrained. It’s still stuck in the dial-up age.

Procuring deep and consistent liquidity is difficult and expensive – especially for new crypto projects.

And as more and more new layer 1 and layer 2 blockchains spin up, liquidity gets increasingly fractured across all these different chains.

For example, decentralized exchange Uniswap exists on Ethereum, Polygon, Celo, as well as on layer 2s Arbitrum and Optimism. This means its liquidity is spread out among those chains.

And any blockchain that is Ethereum compatible, such as Avalanche, Fantom, EVMOS and others, also competes for the same pool of liquidity.

As the Cambrian explosion of the Blockchain Ecosystem continues, liquidity becomes harder and more expensive to source.

This is not only a headache for the projects themselves but also for liquidity providers (LPs) and end users.

Liquidity Mining – A Broken System

Liquidity mining is when a project pays out rewards in its own token to liquidity providers in order to attract liquidity.

Liquidity mining initially kicked off the decentralized finance (DeFi) revolution back in 2020 (the so-called “DeFi Summer”) but it’s a deeply flawed concept.

The majority of crypto projects rely on liquidity mining to generate some initial liquidity for their token.

The problem is not only that this is inflationary and hurts a project’s token price, but such liquidity is mercenary, meaning as soon as incentives dry up, the capital moves elsewhere.

In short, a project spends lots of capital and its token valuation goes down due to the selling-pressure from LPs, without receiving any long-term benefits in return.

One solution to this problem is Protocol-Owned-Liquidity (POL), pioneered by Olympus DAO, which is already in our model portfolio. (For a reminder on how Protocol Owned Liquidity works, check out my analysis of Olympus DAO).

Today, we’re going to look at a project that goes beyond just owning liquidity.

This protocol takes it one step further and creates sustainable liquidity and capital efficient markets across all of DeFi through a convenient decentralized market-making protocol.

Tokemak: Sustainable Liquidity-as-a-Service

Tokemak is a decentralized liquidity network.

The protocol allows for control over where the liquidity flows, and also offers an easier, cheaper way of providing and sourcing liquidity.

It improves upon the status quo for all parties.

Crypto project founders often spend up to half of their time on issues concerning liquidity sourcing, management, and market-making. On top of that, projects pay an average of around $1.25 in their native tokens for every $1 of liquidity secured.

With Tokemak, projects can obtain deep and sustainable liquidity, freeing up resources and reducing one of the biggest expenses by roughly three to four times.

And for a project to direct liquidity to their token, there’s only a one-time cost to acquire TOKE, which is then permanently owned by the project. It’s no longer necessary to constantly issue their own native tokens to incentivize LPs.

Tokemak also improves the situation for LPs. Being a liquidity provider (LP) exposes you to the risk of impermanent loss.

Liquidity pools pair two assets into a pool to enable trading of those assets. Liquidity providers are incentivized to provide assets into these pools because they earn fees which are charged to traders.

Impermanent loss is a new concept coming from the world of DeFi. It’s the idea that liquidity providers can end up with less wealth (measured in dollar terms) providing liquidity compared to just the holding assets.

Impermanent loss happens when the price of one asset in the pool rises or falls a lot relative to the price of the other asset in the pool.

Tokemak doesn’t entirely eliminate impermanent loss, but the protocol has built-in mechanisms for reducing the impact of impermanent loss on LPs.

This makes Tokemak very attractive for LPs because a large percentage of them suffer from negative returns due to impermanent loss.

Liquidity providers also benefit from higher yields and reduced complexity through single-sided staking pools. This means instead of LPs having to manage a pair of assets, they only supply a single asset into a pool.

It’s “set and forget”. This is especially attractive as automated market makers (AMMs) such as Uniswap V3 move to a concentrated liquidity model which requires constant monitoring and adjustments.

Tokemak allows its users to direct liquidity to where it’s needed most.

The protocol is designed in such a way that if users direct liquidity so they earn the most rewards for themselves, it creates the optimal liquidity distribution across the entire ecosystem.

The protocol runs optimally when all participants in the ecosystem are maximally greedy. If each participant chases the highest TOKE rewards, then the system will be in perfect balance and will reward each participant as much as possible.

Infrastructure is defined as a technology upon which other things rely in order to function. Tokemak views liquidity as infrastructure.

Electrical grids allow for the transfer of energy, the internet allows for the transfer of information, and blockchains allow for the transfer of value.

Tokemak is an additional infrastructure layer sitting above decentralized exchanges that moves liquidity between markets and blockchains.

Increasing DeFi’s access to liquidity increases the bandwidth of value flow across the entire Blockchain Ecosystem.

And while providing this liquidity-as-a-service, Tokemak itself is building up its own reserves, or Protocol-Owned-Assets (POA).

The end goal for Tokemak is to become a complete liquidity sourcing and management protocol that allows developers to build their projects without having to worry about liquidity.

It’s one of those rare projects that brings something really creative and new to the table. It definitely has the potential to embed itself into the Blockchain Ecosystem as a core DeFi infrastructure with impressive growth potential.

Let‘s take a detailed look at Tokemak using the T4 Method.

T1: Technology

Market-making is a fundamental part of the financial system that few investors are aware of because it happens in the background.

Market makers profit from the difference between the bid and ask prices on their trades.

Without market makers, far fewer trades would happen, and companies would have more limited access to capital.

In the crypto market, market-making started on centralized exchanges (CEX) and eventually moved to decentralized exchanges (DEX) once the trading volume became big enough.

The crypto market has many hidden market-making giants such as Wintermute (infamous for losing hundreds of millions of dollars from hacks but still being solvent), Jump Trading, GSR, Alameda Research (founded by crypto billionaire and FTX owner Sam Bankman-Fried), Flowdesk, Auros, Gravity Team, Keyrock, and others.

The three functions traditional market-makers typically centralize are capital provision, market knowledge as to what and where to trade, and trading technology and expertise to price assets.

Tokemak decentralizes and crowd-sources these three functions across the Blockchain Ecosystem. It segregates the tasks into three separate participants.

1. Liquidity providers (LPs) bring capital into the system
2. Liquidity directors manage where liquidity needs to flow
3. The protocol’s algorithm that prices the assets on decentralized exchanges

Token pools at Tokemak are called reactors. There are two types of reactors.

Pair reactors accept either ETH or USDC.  They are single-sided, globalized pools which the reactors draw upon to provide double-sided liquidity on different trading venues across the DeFi landscape.

(Pair Reactors use ETH and USDC because they are the most common assets paired with other tokens to bootstrap liquidity pools across decentralized exchanges.)

Sidenote: Both of these pair reactors offer a double digit yield (around 10.5% right now). They are a good place to park some idle cash.

Token reactors, on the other hand, are the liquidity balancing and directing pools.

On one side of the reactor, liquidity providers deposit assets like gOHM, FRAX, FXS, LUSD, ALCX, SUHSI, SNX and a few others.

On the other side, liquidity directors determine where that liquidity will go by depositing Tokemak’s governance token, TOKE.

Notice how Olympus DAO and Frax show up in this still very short list of tokens that have their own reactor. That’s because the most innovative, bleeding-edge crypto projects support each other and work together. (And both of them are already part of our portfolio.)

Here is an example of how Tokemak brings together these two types of reactors and deploys its liquidity:

Let’s say Tokemak wants to deploy $10 million worth of liquidity in the ETH/FRAX pool on Uniswap.

It simply takes $5 million worth of ETH from the ETH pair reactor and $5 million of FRAX from the FRAX token reactor and automatically deploys it on Uniswap.

Liquidity directors are responsible for picking which pairings to use and on which exchanges the liquidity gets deployed. Liquidity directors receive voting power based on the amount of TOKE they’ve staked.

Tokemak uses TOKE emissions as rewards for liquidity providers and liquidity directors to balance the reactors.

Each reactor has its own APR based on supply and demand.

When a large amount of assets have been deposited into a reactor but there’s only a small amount of TOKE directing the liquidity, the protocol allocates more TOKE rewards to the liquidity director side.

This increases the yield liquidity directors can earn, which in turn encourages more participants to direct the liquidity.

This mechanic also applies in the opposite direction.

If there’s a large amount of TOKE staked in a reactor relative to the assets deposited as liquidity, the protocol allocates more TOKE rewards to the asset side of the reactor to encourage liquidity provision.

Basically, Tokemak uses TOKE rewards to create a balance between the value of the assets deposited as liquidity and the TOKE staked by liquidity directors.

This process outsources liquidity sourcing and management for crypto projects in an efficient and cost-effective manner.

The Singularity

LPs and liquidity directors earn attractive yields that come from TOKE emissions.

On the flip side, Tokemak’s liquidity network as a whole earns trading fees from its liquidity provision across DeFi.

These revenues go into the treasury and are Protocol-Controlled-Assets (PCA).

PCA are used to further provide liquidity and cover LPs for impermanent loss.

As the size of the PCA pool grows, the goal is to emit less TOKE and start paying out a portion of the revenue instead of TOKE as LP rewards.

At some point, Tokemak will reach The Singularity.

This is the moment when the protocol has enough Protocol-Controlled-Assets that it doesn’t even need third-party liquidity providers.

It becomes self-sustainable. TOKE emissions will stop. And TOKE holders will be in the very lucrative position of directing some of the protocol cash-flow to themselves.

So at that point, you have this liquidity infrastructure that owns enough assets itself to provide massive liquidity bandwidth across DeFi.

The Singularity is leading to a Liquidity Black Hole

Tokemak estimates that its liquidity network could lead to a three to four times reduction in what projects will need to pay for liquidity.

And savings will likely be even higher as Tokemak approaches The Singularity.

By spending less on liquidity incentives, projects can reduce token emissions and inflation. This means token holders experience less dilution, leading to stronger tokenomics and more long-term holders.

Lastly, Tokemak gets to keep collecting fees from its market-making services in perpetuity.

Next, let’s take a closer look the team behind this project.

T2: Team

The Tokemak project and team spun off from Fractal, a professional DeFi market making firm.

I don’t know the exact size of the project’s team, but last year it was already around 20 people strong.

By now, Tokemak is a well-established DAO, albeit still relatively centralized.

Let me briefly highlight some of the key team members.

Tokemak was founded by Carson Cook. He has a PhD in Physics and a background in Fintech and wealth management. Carson got into crypto in 2018 with the goal of solving liquidity issues in the crypto space.

CJ Wheelock is the Head of Partnerships. He’s responsible for on-boarding additional DAOs to Tokemak. He has a background in business development and sales in the technology sector.

Craig Braun is Head of Growth & Product. He has over ten years of experience as an executive in global business development and marketing roles as well as in consulting with a top-tier consulting firm. He has an MBA from the University of California.

John Mattox is Tokemak’s CFO. (He also serves as CFO for Fractal.) He has experience as a CFO at various companies as well as in a leadership role at ING Capital. John has an MBA from Duke University.

Hennadii Ivtushok is a senior software engineer for Tokemak. He has many years of software development experience in various positions as well as blockchain development experience in two previous jobs.

Not all team members have public profiles. There are plenty of additional engineers and data analysts.

The people I’ve highlighted above should give you a good idea that Tokemak has a serious and capable team that will be able to deliver on the Tokemak vision.

Let’s move on to the financial side of things.

T3: Tokenomics

Tokemak’s native token, TOKE, can be thought of as tokenized liquidity.

Staked TOKE gives users the ability to generate and control liquidity.

When project XYZ wants to set up a token reactor they will do a token swap between XYZ and TOKE, so the project gets enough TOKE to stake and direct liquidity to themselves. And Tokemak gets a reserve of XYZ tokens to use as the first layer of protection against impermanent loss.

At its core, the value of TOKE is proportional to the value of the assets controlled by the protocol.

In other words, the bigger the reserve and the more LP assets Tokemak controls, the more liquidity there is to direct, and the higher the value of TOKE.

This also means that the more partnerships Tokemak can make with other projects, and the more token reactors are brought online, the higher the value of TOKE.

And each new partner has an incentive to buy and stake more TOKE in order to direct liquidity for their own tokens.

For example, Olympus DAO will want to have TOKE to direct the liquidity of gOHM within the Tokemak protocol.

TOKE has a maximum supply of 100 million. So, over the long-term, there is a guarantee for token holders that their value won’t be inflated away.

Initially, however, there is inflation in the TOKE supply as the project pays out TOKE to suck in Protocol-Controlled-Assets.

Only once The Singularity has been reached, will TOKE be in a much stronger position.

Right now, TOKE trades around $0.98 and has a market capitalization of only $16.5 million.

If you consider that Tokemak has a TVL of $74.2 million and $48.4 million of deployed liquidity, that’s very cheap.

47.5% of the token supply is in the hands of investors, contributors and team members. Another 8.5% is held by DAO partners.

The vesting cliff for these tokens expires February 7th, 2023. The tokens will then vest over one year.

Normally, that would be a concern.

However, because Tokemak was still in the bootstrapping phase with high TOKE emissions when the bear market hit, the TOKE price got crushed.

So it’s unlikely there will be a lot of selling at rock bottom prices.

Secondly, the tokenomics are about to be upgraded with a new locking mechanism that will change things. (Covered in detail further below).

Thirdly, there is a “Toke Wars” scenario on the horizon.

Currently, there are 9 DAOs using Tokemak and accumulating TOKE. As Tokemak fully rolls out V2 and increases its Protocol-Controlled-Assets, we can expect the “Toke Wars” to develop, similar to how DAOs today fight to control Convex and Curve tokens (the so-called “Curve Wars”).

In order to accelerate the growth of Tokemak’s Protocol-Controlled-Assets, the project is refining its reward logic and introducing a new token called accTOKE.

This token will improve capital efficiency and reduce TOKE emissions.

(For a deep dive into the improved economics you can check out this article.)

Staking TOKE into accTOKE will earn you dividends and is a further step towards governance controlled operations.

The rewards accrued by Tokemak’s PCA deployments will be sent to accTOKE stakers in ETH terms (earned as wETH).

And accTOKE stakers control the parameters of the PCA deployments.

accTOKE will also be a main stepping stone to permissionless reactors, allowing protocols to provide their reactor with the necessary reserve.

One can think of accTOKE as a “vote-locked” token, allowing holders to lock up TOKE in exchange for a number of benefits — not only further aligning long-term holders with the protocol, but also expanding the protocol governance, mechanics, and earning potential for those TOKE holders who opt into the accTOKE model.

The new dynamics will reduce rewards for liquidity direction, break the reflexivity with the value of TOKE, and allow much improved value accrual.

Liquidity Providers (LPs) and Liquidity Directors (LDs), who are not staked into the new accTOKE mechanism, will continue to receive TOKE rewards for their respective actions in the system.

In summary, the new accTOKE model is a massive protocol improvement and part of the V2 roll-out (more details below).

For an overview of how many assets the protocol controls and how it deploys them, check out this Dune dashboard.

T4: Traction

Exactly a year ago, less than two months after unveiling the first reactors, Tokemak had already hit over $1 billion in total value locked.

At its peak, the Tokemak treasury controlled $3 billion of assets.

At that time, it hadn’t even fully launched all its functionality yet.

Even today, Tokemak is still in the start-up phase. And the majority of funds have been flowing out of the DeFi space during the bear market.

This is giving us an excellent entry point right now, immediately before a major inflection point in both the overall crypto market as well as the imminent launch of Tokemak V2.

The team has spent much of the last year modeling out the emissions and rewards mechanics, and tweaking the algorithms to ensure the protocol deploys liquidity as profitably and efficiently as possible.

Over the next quarter, the Tokemak app will receive a complete face lift and a major upgrade to the back end systems.

V2 will change the way liquidity is deployed from a “push” to a “pull” model, where self-serve users will specify their requested liquidity needs, and the protocol will organize the various participants.

On the road map below you can see a packed delivery schedule for the coming weeks.

It’s also worth noting that at the moment, Tokemak has no direct competition.

Plus, next year will see the launch of Membrane. Membrane is an OTC and credit-layer protocol being designed by Carson Cook. It is expected to directly integrate with Tokemak as a liquidity direction venue.

The addressable market for Tokemak is all DeFi liquidity. As the team further refines and builds out the protocol, adds new partnerships and as capital begins to flow back into DeFi, the sky is the limit for TOKE.

With a paltry valuation of only $16.5 million, Tokemak has true 100x potential over the next 2 years!

And right now, at the end of the bear market, before the V2 launch is the perfect time to buy in.

“He who controls the TOKE controls the flow of value.”

CryptoExponential Educational Series Part I Blog Post: Learn & Onboard Onto Decentralized Perpetuals: A Deep Dive Into GMX

Disclaimer: As with everything on this site, this article is for informational purposes only and is not advice of any kind. I simply share my experiences and my opinions for information. I am not a financial adviser and I am not providing investment advice or financial or legal advice of any kind. Cryptocurrencies (and most business opportunities) are high risk. Many of the opportunities I discuss exist in new, high risk and unregulated markets. Some methods require significant investment of time and/or relevant skills. Please do your own research and due diligence; do not blindly follow anyone!

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