About Liquidity Baking (LB)

About Liquidity Baking (LB)

Summary:
I think LB is great. More liquidity reduces the cost of participation for huge actors. Inflation funding is great. Therefore, LB is great.
However, there has been a bit of a kerkuffle around it. As such, I’ll express my opinion for it. I am also soon releasing a no-LB proposal, so that people cannot undermine the arguments I’m bringing in good faith to this discussion.
By the way, this post is in my name only, and does not reflect the opinions of people working at Marigold and LigoLANG.

Intro

I’m usually more focused on dev matters. Specifically, my main job is to bring L2s to Tezos, which I believe is the best use of my time and the best way for me to contribute.

But as of right now, Ithaca might not pass. As such, I’m finding myself reluctantly pulled into what I consider to be an unnecessary debate about the benefits of LB, which to me are clear.

Step 1: Gish Gallop

LB is obviously a strong net positive to Tezos. I don’t really think there is a need for a synthesis of the pro-LB and anti-LB positions. From my point of view, the anti-LB position is simply wrong.

Unfortunately, the right arguments are technical and not immediately obvious. While many, including Arthur, took it to heart to defend it through correct arguments, this approach is not always the most convincing one.

Meanwhile, detractors engaged in a giant gish gallop against LB: i.e. a huge pile of bad arguments. So, while you can refute all those arguments individually, to a non-technical observer, it looks like there is something when there is nothing. On top of this, it is good to remember that:

  • Sometimes, “There is no smoke without fire”. Especially when some people are committed to create debates where there is nothing to be debated.
  • “I’m just asking questions” is not a valid defense. Especially when the questions all point to the same direction, are rethorical, and there is no acknowledgement of them having been misguided when they get answered.

Step 2: Change the debate

The best way to notice is this is the following: no one has any idea what the main counter-argument to LB is. There are various feelings and small counter-arguments involved, but no primary reason why it should not get voted. The closest thing to it would be the choice of tzBTC, but this has already been addressed numerous times, with the detractors not addressing the replies nor changing their stance whatsoever.
The worst thing is, the current discourse is not even about LB anymore! It’s about the lack of choice around LB.
From my point of view, the reason behind this is that the debate has moved on: people have seen that it does not really make sense to disagree with LB on its merits, so instead, to keep the debate going, the disagreement is now about the form. For instance, “TF should have asked core devs to offer a different pair on the behalf of some bakers!”, “TF should have asked core devs to offer a no-LB option on the behalf of some bakers!”, etc.

My position: explained

What is LB?

There are two components to Liquidity Baking: the first one is the “Liquidity” part, the second one is the “Baking” part.

The “Baking” part is very easy to understand: it is simply funding stuff with inflation. Many things can be funded with inflation:

  • The honesty and expenses of the consensus participants (miners, bakers, etc.)
  • The work of core teams
  • Government Spending
  • Liquidity!

The Tezos whitepaper already mentioned non-standard inflation funding a long time ago. Most notably, inflation funding marketing by giving 100k$/week to various charities. (Coincidentally, this amounts to ~5mln$ per year, which is ~.15%/year of inflation, not that far from LB.)

So, let’s move to the “Liquidity” part. Here, we are talking about how much liquidity there is in a given “pair”, “swap”, “Dex”, “CFMM”, “AMM”: concretely, a smart-contract that allows exchanges between a pair of tokens. People can buy/sell one of the tokens of the pair, and the smart-contract will provide some of the other token of the pair at a rate computed automatically.
The liquidity is the amount of tokens that is locked in the contract, as it needs some tokens to satisfy the buy/sell orders.
Usually, liquidity is provided by Liquidity Providers (LP). People putting money in the smart-contract, and getting a fixed-cut (.2% for instance) of all buy and sell orders going through the exchange.

The goal of LB is to incentivize the liquidity of such a pair through inflation funding. Straightforward enough.

LB Good

Now the question is: why would we want to do that? What is the benefit of having a lot of liquidity on a single pair?

This is where things usually become very technical very quickly. But basically: the more liquidity you have in a pair, the more stable its price is in the face of spikes in the order flow. This is the basic mechanism that underpins everything.

Another mechanism that is important to have in mind is that if you have one pair that lets you trade between A and B, and one pair between B and C, you have an indirect pair between A and C.

From this, you derive a lot of benefits:

  • DEXes become more resilient to short-term shocks (someone buying/selling a lot, market manipulation, temporary bad buzz)
  • It becomes possible to trade big amounts without having to go through a centralized exchange, which makes Defi possible
  • It becomes possible to buy/sell large amounts of XTZ, or tokens on Tezos, much more cheaply
  • This makes it much less risky for people to hold XTZ, as they can liquidate their position more easily. Which makes it a better store of value
  • This makes it much less risky for people to come and arbitrage Tezos’ Defi ecosystem, which makes it much more efficient

The obvious concern here is inflation. But even an entire percent LB would be comparable to baker fees (not rewards!), and both would be absolutely dwarfed by typical moves in crypto markets.

Conclusion

As one might see, I’m a bit annoyed with the current situation. LB is a net positive, and completely plays to Tezos’ core strength of onchain governance.

To show that I am saying all of this in good faith, and that I am not trying to censor alternative proposals or whatever, I’ll just make a no-LB proposal. It is not one that removes the code of LB, it merely sets its sunset to right after the deployment of the new protocol, but that will work.

Cheers,
Gabriel

25 Likes

LB is starting to work better and better. Making a stand now against it was foolish at best and dangerous at worst.

Let’s think of ways we can make LB work for everyone and generally use this as an opportunity to build better human consensus pathways.

9 Likes

You, sir, deserve a medal.

As someone who also believes LB can be net-positive for Tezos (in the long run), I felt to reside with the Nay voters this time round out of protest of their voices not being heard.

It is very unlikely that a No-LB will pass, but to be totally understanding of their voices, it needs to be done. We will most likely end up with an LB integration in I upgrade due to No-LB not passing.

Well done!

5 Likes

Very Cool! I too tried to make a “no-LB proposal” my approach was to set the Escape Hatch to 11.11%.

Ps2knvQUqKBNA6pm1YV65NLmeHWroKM5cWV7aWtuWnZfzeqoBGE

it was fun to work on and I not plan to inject it. I offered it to the anti-LB crowd and they just didn’t seem to care / made jokes for hours.

the one you present will be much better than the one i have presented as mine takes a very dirty approach.

i deleted the liquidity-baking-tests because the math involved to solve the tests properly with 11.11% was a bit too much for me to do last night at 1AM.

I am sure your supplied protocol proposal for anti-LB will be much more professional.

Still, I do not believe this will resolve the debate. They plan to just use Nay Votes again during exploration of Ithaca Round 2.

2 Likes

I agree with OP, LB is a good idea. The real problem is that only one governance proposal can be considered at a time after the proposal phase. In order to enable smooth governance in the future we need it to be possible to have multiple proposals in different stages going on at the same time.

6 Likes

PosDog said he will upvote no-lb, but if lb one wins, he will support it in later stages. It was all about choice for him.

3 Likes

Thanks for outlining the positive case for continuing LB. Unfortunately much of the argument elsewhere seems to just be LB supporters arguing with the “LB is the devil and is a conspiracy” minority, but without taking the time to explain why it’s good or what the actual benefits for Tezos are.

I realise nobody is going to bother to make a full technical justification when talking to somebody who will never be convinced and isn’t arguing in good faith. That isn’t the case for everyone though, and I feel like some bakers might have been convinced had things been presented differently. For example I’d have loved to see a detailed blog post with stats detailing how LB had been going so far, and some more detailed explanation of the reasons why Nomadic Labs etc. felt that liquidity baking was a net benefit and should continue to be extended. I think if an actual choice and some solid justification had been offered in the first instance (rather than just “we’ve extended LB for ten months”), the proposal with LB might have attracted more support.

2 Likes

Thanks @galfour

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tbh Arthur spent enough time explaining why LB is net good in all the chats, also there have been a few posts that sum up the info
So right now it’s mostly either a NL-give-us-a-choice camp or those who have a strong opinion and won’t listen to any explanation
I’m gonna only touch the second camp here
AFAICT it is split into two parts, no-LB(minority) and no-tzbtc(majority)
We do have a really poor choice of assets on tezos now, tzbtc isn’t perfect, others are even worse
It kinda comes down to a decision whether subsidizing a xtz\tzbtc pair is ok enough or we should wait an undefined amount of time until a better asset comes to tezos
And IMO a bird in the hand is the right way. besides we’re seeing some efforts to make tzbtc more available, flat curve amm announced. I’d be happier if entities behind tzbtc pushed its listings on centralized exchanges but I guess we have to admit the reality tezos is gonna tezos

5 Likes

Thanks Gabriel for wrapping this up!
That’s exactly what’s needed,
with this proposal the no-LB supporters who have no skills to code or even verify the code themselves have an option they asked for from a person who is trustworthy and respected in the community
And thanks for you time and effort, the more we grow the more developers will be able to help us strengthen the governance and the ecosystem

3 Likes

Thank you @galfour. I am on board with all your points.

The thing is, Tezos governance was designed to be a political space, and this means we have to “play politics”. This means putting the arguments forward and educating decision-makers (i.e. bakers)

We are off to a good start with your post, with the interview from @murbard and the xtz.news deep-dive. Let us make sure we continue advocating why we think tzBTC LB is the best way forward on all channels.

3 Likes

This was a thought provoking post I saw on the main Tezos subreddit, before it was censored.
———
Psychological analysis of Ithaca opposition

This post isn’t meant to debate the merits of LB or non-LB, but rather to explore the driving force behind the opposition to LB, which I argue, is actually much larger than just LB. I suggest that those opposing LB, causing Ithaca to fail, are more motivated by the broader economics of the XTZ ecosystem, rather than single issue LB voters. Please review the following tweet prior to reading the remainder of my post, as it helps thread a narrative I believe explains the true opposition to LB.

Really, read the tweet, it’s pivotal to understanding the psychology behind the opposition to LB, an opposition so intense it caused a network upgrade to fail.

I argue, that the same people that opposed LB so fiercely, would, in fact, be staunch proponents of the same exact proposal if XTZ were >$50. When you dig down into what the opposition is actually saying, this is what it all boils down to. LB isn’t actually the issue. The economics of XTZ is the issue. Until we see improvement of this metric, I fear that this faction will become increasingly obstructionist, even to the point of inflicting damage on the network as a misplaced form of retribution.

Recently, we’ve seen a similar dynamic play out in the eos community. The economics of eos was in a languishing/declining state for a very long time, until elements of the community were able to mobilize other ecosystem participants into taking drastic governance actions. The result? Via governance, the eos community froze the eos foundation’s funds. Minority elements of the Tezos community are already suggesting such radical action.

If you didn’t read the prior tweet, now is a good time to do so.

The radical, minority faction of the Tezos community that blocked Ithaca is gaining strength and adherents as the economics of Tezos fails to remain competitive in the crypto sphere. How much stronger will they be in 6 months, if Tezos economics fail to improve? Will they begin obstructing all network upgrades, or worse, rally for radical action as we saw with eos?

For the strength of the network, it is absolutely imperative that we focus on the economics of Tezos, with future upgrades incorporating mechanisms which directly result in value accrual to XTZ. Failure to do so will result in further fracturing of the community, potentially with unrecoverable detrimental effects.

6 Likes

Additional agreement Gabriel
Small precision, no DeX of Tezos benefited from the liquidity baking today. It represents a derisory volume on Quipuswap and nothing on Vortex / Plenty
Hence the need to choose well
Ping @KevinMehrabi

1 Like

Thanks for your post. Full disclosure upfront, I am one of the owners of Kryptstar and we voted “nay”.

I fully agree with the benefits of LB and support LB in principle. As far as I can see, few people, if any, are against LB per se in this debate. The “kerfuffle” arose purely because the Ithaca proposal bundled a protocol update with an extension to the LB sunset period, which was perceived as trying to steamroll through the sunset extension. To be clear, this bundling is the reason Kryptstar voted “nay”. (I cannot speak for the reason PosDog and other “nay” voters had).

Thank you for your plan to put forward a new Ithaca proposal without the LB sunset period extension. That’s all we (Kryptstar) wanted and we will vote “yay” for such a revised proposal.

We can then have a separate discussion about the future of LB. The current implementation of LB (tzBTC/XTZ pair) has issues around the choice (or lack thereof) of asset pair, transparency around the economic beneficiaries and the escape hatch mechanism (virtually impossible to reach threshold in practice). I look forward to a constructive debate around how to improve and implement a better LB going forward.

3 Likes

Next time, it would be great to ask your delegators.

From a different point of view: I have no idea who the majority of my delegators are. I have no idea if they follow me on Twitter or check up on my Agora or Reddit posts. Basically, I can’t ask my delegators because I don’t know who they are or how to contact them.

I’m very happy to take my delegators’ opinions into consideration when casting my vote. But if they care about how I vote then it is their responsibility to reach out to me and let me know their opinion.

LB is not about benefits for any dex or dexes altogether.
However if a dex has an xtz/tzbtc pair it’ll be arbed with the LB DEX, more volume and fees for lp token holders

You can publicly publish your intention before casting vote. Then you will see.

1 Like

This is one of the biggest challenges of tezos this year.

For the strength of the network, it is absolutely imperative that we focus on the economics of Tezos, with future upgrades incorporating mechanisms which directly result in value accrual to XTZ.

What do you suggest?

3 Likes