Boundary-pushing innovations tend to generate buzz before being fully embraced by the wider DeFi community. The protocol’s monetary trade policy is the newest on the horizon. It is already considered by some to be the evolution of liquidity mining, despite being relatively new to the space.
Policy proponents say this will greatly benefit the DeFi ecosystem, but it’s worth examining exactly what the protocol’s monetary trade policy is, how it compares to the traditional DeFi economy, and whether it has really the potential to revolutionize the crypto-economic space.
What is the monetary trade policy of the protocol?
Protocol Monetary Trade Policy (PMTP) is a set of monetary policies that use a cryptocurrency protocol’s influence over currency trading or transfers to support the health of the protocol and its base tokens. In theory, this may eventually eliminate the need for inflation. The policy was invented by a team of crypto economists at Sifchain.
One of the main objectives of the protocol’s monetary trading policies is to help attract external liquidity while increasing the total value locked (TVL). It does this by promoting a cryptocurrency token such as ROWAN, creating an attractive option for earning rewards. This, in turn, helps drive external demand to pool assets and encourage buying and staking/holding of the specified token.
“Sifchain sees the Protocol’s Monetary Trade Policy as an innovative suite of tools that can provide flexible and powerful utility alongside other functionality, such as margin trading. These policies would allow the governance of the DAO to decide the how to move these different monetary policy levers, which would bring immense value to traders and liquidity providers.
So far, Sifchain has introduced one of these policies in the Ratio Shifting pool. In the future, more may 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 Business Development Manager Casey Arrington. But how exactly does the protocol’s monetary trade policy differ from other economic models?
How the protocol’s monetary trade policy differs from traditional DeFi economics
A typical decentralized exchange (DEX) has at least one liquidity pool that allows users to trade crypto assets. It uses an automated market maker (AMM) algorithm to maintain a fair market value for trading token pairs.
Consider a pool of liquidity with tokens A and B. The pool starts with a 50-50 ratio in value for the two assets. This ratio must be maintained at all times. So, as trading takes place and the proportion of tokens in the pool changes, arbitrage opportunities are created, allowing traders to capitalize on the price gap.
For example, as more people trade asset A for B, there will be more A in the pool and less B. This lowers the value of A, reducing its purchasing power relative to B. On the other hand, the value of B rises, increasing its purchasing power relative to A.
Protocolary 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 when users trade tokens. These policies can be used as tools to incentivize and encourage user behavior to protect the health and price performance of a liquidity pool.
A common policy in most DeFi protocols is to use inflation, where the protocol makes new tokens to give to users based on certain activities. With the change in pool ratio (and other monetary policy mechanisms), instead of minting new tokens, the protocols alternately adjust other economic parameters to encourage certain behaviors.
The adjustments are decided by the members of the DAO. For example, governance tracks several metrics, such as external liquidity, before making decisions. If external liquidity is low, they will propose a policy to tap into external liquidity. The DAO then votes to approve the policy. Once implemented, the purchasing power adjustment takes effect.
Using a ROWAN (Sifchain’s token) USDT trading pair as an example, if the protocol’s monetary trading policy passing pool ratio is set for an increase in purchasing power of 2% per day:
- A ROWAN buys 1 USDT in block 1
- A ROWAN buys 1.00005787037 USDT in Block 2
- A ROWAN buys 1.00011574074 USDT in Block 3
This example shows how the Monetary Trade Policy Protocol’s Pool Ratio Change Tool makes very subtle adjustments to a token’s purchasing power 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 monetary trade policy protocol.
Sifchain states that unlike traditional liquidity pools where cryptocurrencies influence monetary policy primarily through inflationary rewards, the protocol’s monetary trade policy aims to influence the number of opportunities a token holder has to trade its existing quantity at a specified ratio.
It is important to mention that the monetary trade policy of the protocol will not fix the price of a token at a certain level. The price will always change depending on the balance of the liquidity pool. Additionally, the purpose of these policies is never to restrict the trading of a token; holders are free to trade a token anywhere, on any exchange.
What kinds of advantages does it offer protocols?
One of the main advantages of the protocol’s monetary trade policies is that they help reduce inflation. By increasing the value of a token on an exchange, the policy can help fewer tokens have the same buying power.
The protocol’s monetary trade policy can also be a useful tool for attracting liquidity. The subtle increases in the purchasing power of the token make it more valuable to accumulate. Additionally, there is an increase in rewards obtained by providing liquidity and staking/delegating. This encourages people to pool external liquidity with that particular token.
Since these policies in DAOs must be voted on by community members before they can be implemented, users can directly influence their feedback. Moreover, they have the opportunity to be part of an evolution of microeconomics. Thus, new users and projects have even more reason to add their liquidity to the protocol.
The protocol’s monetary trade policy also has the potential to trigger 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 attracts liquidity providers, creating more liquidity in the protocol.
Note that members of a DEX or DAO do not have to do anything to benefit from the protocol’s monetary trading policy, although they are encouraged to participate in governance. Policies are automatic. So as long as you have assets in the pool, you will still enjoy the benefits.
Sifchain recently incorporated the Protocol’s Monetary Trade Policy Pool Ratio Change Tool after their DAO vote adopted the policy, making it the first protocol to bring these real-world monetary policy tools to the level of the protocol. Community members were very impressed with its potential benefits and excited to be a pioneer of this new monetary policy.
Sifchain saw the policy vision and a SifDAO member noted that “the monetary trade policy protocol is like early nuclear research. It can be incredibly loud; we’re just freaking out over the fallout. But this thing can absolutely win the market for us.
However, things did not go exactly as planned. To protect Rowan’s value gains and Sifchain’s liquidity, Ratio Shifting would eventually need to be paired with DEX Liquidity Protection, another key feature of PMTP. Unfortunately, Sifchain did not expect a major selloff to occur before the rollout of DEX Liquidity Protection. After experiencing some problems during a bear market, DAO members voted to return to their original policy of balanced pools.
It was also noted that these policies could be better implemented as complements to other features. For example, purchasing power adjustments can be extremely attractive when coupled with the ability to take margin positions. Margin traders looking for any type of signal to help them with their positions would likely welcome buying power adjustments as additional helpful leverage.
Still, Sifchain believes these policies have the potential to change the DeFi economy for the better. These policies are most effective when viewed holistically in a way that can complement each other and handle any type of market. So with a few minor tweaks, these policies are likely to be beneficial in the future.
A growing movement
Ceremonial Monetary Trade Policy is an exciting innovation in the crypto space. Currently, Sifchain dedicates a lot of time to community education initiatives. For anything to succeed, including any monetary policy, the community must fully understand its power and its limits. Sifchain learned this with the previous launch of the Monetary Trade Policy Protocol. The team is now ensuring that this lesson is continued with the core features that are top priorities in its roadmap, such as margin trading and Omni-EVM.