The Case for Tokemak-ximalism

Unlocking Web3’s electrical grid

Nick Hotz
13 min readDec 22, 2021

The Importance of Liquidity

Nearly all of humanity’s most important inventions throughout history have involved the ability to transport its most precious resources to allow for greater optimization of human time and energy. Most importantly, the taming of fire allowed humans access to stored potential energy to ward off predators, endure cold temperatures and cook food. As society advanced, we discovered new ways of manipulating energy, culminating in the invention of electricity, a novel way to store and distribute energy with nearly infinite applications.

For some, like the creators of this anti-electricity propaganda, this new technology was hard to understand and even something to fear. But, in the decades that followed, the infrastructure was built to give society the ability to easily transport energy; this proved to be an incredible boon to human living standards and productivity.

The distribution of another scarce resource, information, has catalyzed societal change in revolutionary inventions like gossip, the printing press, and most relevantly, the Internet. As governments and corporations have connected the world with fiber, Internet penetration rates have reached 60%, but have already dramatically altered everyday life for much of the population, and indirectly affects even those not connected to the web.

Value is another key resource that humans struggled to move and distribute throughout history. The invention of money arguably paved the way for civilization as humans could finally coordinate in non-collaborative groups without the need to barter for goods. But even after the invention of money, value remains in many cases difficult to quantify and hard to exchange with non-trusted parties.

In Web3 today, we are sitting at a similar point to the inventions of electricity and the Internet prior to their infrastructure buildouts. Just as those inventions appeared as toy-like or even something to fear prior to the distribution, blockchain and digital asset technology has both those who fear it and those who think it is a plaything that will amount to nothing. Whereas the electrical grid moves energy and fiber networks move information, Web3 moves value. And the infrastructure for moving value is liquidity. I believe that the introduction of deep and sustainable liquidity across all applications of digital assets will catalyze a revolution in the potential of Web3, unlocking new applications previously impossible without an ocean of liquidity.

Enter Tokemak.

Source: Tokemak

What is Tokemak?

Tokemak is an application built on Ethereum that allows users to deposit idle digital assets in order to earn rewards in its native token, TOKE. When assets are added to Tokemak, they get placed in siloed pools called “reactors”. Each reactor has two sides, the asset side and the TOKE side — where users stake TOKE in order to direct the added liquidity to exchanges.

One of the protocol’s main objectives is to keep the reactors balanced at a 50/50 weighting between the asset and TOKE, since this state means that all available TOKE is directing all available liquidity, the maximally efficient outcome. The provided assets are then paired with a collateral asset like ETH or USDC and sent off to provide liquidity in decentralized exchanges like Uniswap and Sushiswap.

Tokemak’s Reactors. Source: Tokemak

Looking at the screenshot above, a SUSHI holder could deposit SUSHI into Tokemak and earn 61% APR, while a TOKE staker may prefer to direct liquidity of FXS or ALCX given the slightly higher reward rates (61% vs. SUSHI’s 60%). Notice that even at its early stage, reactors are already quite well balanced due to Tokemak’s dynamic reward rates that adjust as reactors come into and out of balance.

Why Tokemak Matters

Tokemak unlocks key new primitives for DeFi that, put together have the potential to radically alter the current landscape.

Capital Efficiency

Idle tokens in wallets, treasuries and escrow will be put to use, ensuring deep liquidity throughout the ecosystem for even the newest tokens. Tokens won’t even have to be trading to gain liquidity, upcoming projects could simply mint a token and deposit in Tokemak to get pricing started in automated market makers (AMMs) like Uniswap and SushiSwap. This means in the future, Tokemak won’t just be liquidity for tokens, it will be liquidity for ideas.

Sustainability of Liquidity

One of the key issues for protocols today is the inability to sustainably maintain liquidity for their tokens. However, protocols benefit significantly from collaborating with Tokemak. By establishing a reactor, protocols can gather liquidity for their native token without needing to resort to inflationary incentive programs. We will be able to do away with these untargeted programs where mercenary yield farmers suck protocols dry and subsequently dump the tokens, pushing prices lower and shattering community spirits.

The liquidity issued via Tokemak is reliable, and therefore much less likely to get pulled when it is most needed. A protocol can also guarantee reliability by owning TOKE and acting as a liquidity director itself. Critically, Tokemak also dramatically lessens the risk of impermanent loss for liquidity providers. Impermanent loss is the unrealized loss that occurs for liquidity providers in decentralized exchanges when the price of one of the two tokens in the pool changes relative to the other. This is a risk someone needs to take, previously the protocol or its LPs. Instead, by using Tokemak, it takes on all impermanent loss risk.

Increase in Valuations

After removing the consistent sell pressure emanating from yield farmers on protocol tokens, its reasonable to assume we may see an industry-wide revaluation. Daily trading volume is highly correlated to token valuations. Here’s a graph of trading volume of projects available on Token Terminal plotted against their market capitalizations.

Token Terminal, Arca Internal Research

While some of this correlation may be unrelated, it makes sense that some of this it is causal — higher token trading creates more efficient markets that increases investor comfort and interest. If this is the case, we should see the propagation of sustainable liquidity facilitate higher trading volumes and thus higher market valuations.

Slashing of Expenses

Current protocols that possess reactors needed to win a governance vote called the Collateralization of Reactors Event (C.o.R.E.) to obtain them. Some protocols have found the potential to gain a reactor so valuable that they deployed significant cash incentives to encourage TOKE-holding voters to choose their protocol. The last C.o.R.E. event saw five new protocols chosen and well over $2 million in incentive payments distributed to voters.

But a few hundred thousand or million here and there pales in comparison to what protocols are actively spending today on facilitating liquidity. Tokemak’s new article “The Evolution of DAOs”, gives a case study of these mechanisms in place. It points out the case of Alchemix, who is spending over $130 million in mining issuance per year at current prices. The article estimates that by integrating with Tokemak, Alchemix can reduce its 86% annual issuance rate to 6%, a 93% cost savings.

The applications of liquidity infrastructure

One of the key unlocks that Tokemak can help bring about is the acceleration of social/organizational tokens into the mainstream. Currently, a moderately popular creator has few options to tokenize their brand, with the somewhat unknown Rally among the best options. Still, Rally’s creators suffer from sparse liquidity for even its largest tokens. The option to stand up a reactor in Tokemak would go a long way towards fixing this issue, allowing fans to more easily purchase and swap between creator tokens without feeling as though they are locked up in an investment.

Deep liquidity could also be a huge boon to the gaming sector and gaming assets. The most successful player in the space currently, Axie Infinity, has successfully built its own decentralized exchange, Katana, in order to gather liquidity for its assets, but its unlikely most game producers will be interested in or able to build their own infrastructure for their gaming economies. Future producers could instead set up a reactor in Tokemak for all the necessary assets and gain liquidity without the need to worry about purchasing collateral assets, taking on impermanent loss risk, or managing a Uniswap v3 LP position. Axie Infinity also has a natural synergy with Tokemak in that it could purchase TOKE and direct liquidity to Katana to deepen markets for its native AXS, SLP and upcoming RON tokens.

Finally, Tokemak will enhance profitability and sustainability of revenues for today’s decentralized exchanges. As liquidity positions become easier to create via Tokemak, especially as it goes multi-chain and avoids cumbersome Ethereum L1 gas fees, more idle assets will be able to be provided to exchanges with minimal risk to users. The greater liquidity may catalyze more trading volumes as costs fall for users. And since many protocols will direct their own liquidity via Tokemak, liquidity will become more sticky ensuring depth even during market crashes. While many centralized exchanges go haywire in fast moving markets, the dynamic duo of Tokemak + decentralized exchanges may ensure the latter becomes the go-to venue for trading digital assets.

How To Value TOKE

Tokemak’s TOKE is not just a governance token, but is instead well integrated into the protocol as a core utility. TOKE accrues value in a few distinct ways that I’ll attempt to define and in some cases quantify.

Total Liquidity Directed

TOKE’s value is directly tied to the amount of value locked in the protocol directing liquidity. Assuming reactors are balanced between the liquidity asset and TOKE, every $1 of assets must be directed by $1 of TOKE. As a result, the value of TOKE should by definition equal the total value locked (TVL) / the circulating supply of TOKE / the % of TOKE staked. TOKE’s price is a direct function of the total liquidity directed (positively related), the circulating token supply (negatively related), and the % staked (negatively related). Below is a guide to thinking about value under various scenarios of TVL and circulating token supply.

Note: Prior to addition of pair assets. Source: Tokemak, CoinGecko, Arca Internal Research

Governance Rights

Individual participants may be interested in determining the direction of the protocol from a personal interest standpoint. However, other actors have more financial motives to be interested in acquiring TOKE.

Decentralized exchanges, for example, may buy TOKE in order to direct liquidity to themselves and to steal market share from competitors. Tokemak also allows them the flexibility to choose which assets they want to direct, so a DEX could, for example, decide they want to strategically focus on stablecoins. The DEX could then purchase TOKE and choose to direct stablecoins into its liquidity pools in order to tighten spreads on these assets.

Protocols may additionally desire TOKE in order to direct their own asset to exchanges. This would prevent them from having to buy a collateral asset like ETH and take on impermanent loss risk in order to provide liquidity.

The ability to control governance decisions should mean TOKE will trade at a premium to financial analyses like those I show below.

Discounted Cash Flow/Book Value

As it begins directing liquidity to exchanges, Tokemak will start accruing trading fees that will become protocol-controlled assets in its treasury. Since TOKE holders have a claim on the treasury assets, these assets act as a book value/floor price. The book value is a function of the total liquidity directed and the ROI of trading fees accrued on that liquidity as well as the time which Tokemak’s assets are providing liquidity. Tokemak can also accrue book value via token swaps with protocols who want to own TOKE, as it has done with protocols winning reactors in C.o.R.E, or by selling liquidity bonds via Olympus Pro, all of which factor into my analysis.

Valuing TOKE in this way is directly related to how quickly and how many assets it gathers, as well as the discount rate you assume. Additionally, asset gathering is a function of TVL and since TVL is made up of both to new assets coming into the protocol and price changes of those assets, pricing becomes reflexive very quickly. I made what I believe are relatively conservative estimates of market beta to account for this. Below are my assumptions that get me to a $191 present valuation, or a $835 valuation with more aggressive assumptions, for TOKE based on discounted cash flows.

Source: Arca Internal Research

Finally, with similar assumptions to the discounted cash flow analysis, we can estimate price of TOKE based on the book value of assets in the Tokemak treasury. Below is the implied floor price of TOKE based on that forecast.

Source: Arca Internal Research

Liquidity Efficient Frontiers

To better illustrate why Tokemak is such a big improvement over the current model, I take the portfolio management concept of “efficient frontiers” to show cost/risk and reward of liquidity under various scenarios. Efficient frontiers depict the theoretical maximum return per unit of cost achievable by portfolios of various assets. Here, I’ll compare the amount of sustainable, reliable liquidity gained relative to the cost of that liquidity under various paradigms of liquidity incentivization.

Prior to the invention of liquidity mining, protocols were only able to bootstrap liquidity by doing it themselves. I.e. selling their native token from their treasury (with what liquidity?) to buy ETH or USDC and provide liquidity in Uniswap or Sushiswap themselves. In this case, the protocol would additionally bear extreme risk of impermanent loss if the price of their token was particularly volatile. Note: this issue has been solved by Uniswap v3 and the upcoming Sushi Trident launch, however both still require liquidity providers to manage a complicated and fluctuating LP position that may or may not be earning fees depending on the price. Tokemak’s liquidity provision, by contrast, is extremely simple, with the protocol abstracting away most of the complexity.

Source: Arca Internal Research

Fortunately for the ecosystem, this bygone age ended when Compound Finance rolled out its COMP token and followed up with the first instance of liquidity mining, a program which incentivizes users to use protocols and provide liquidity for their native tokens.

Liquidity mining has arguably created the foundation of DeFi today, with capital rotation heavily based on different liquidity mining schemes generating high yields in the space, encouraging borrowing for leverage, and boosting trading on DEXs. The invention of liquidity mining gave protocols more options, increasing the opportunity set and pushing out the efficient frontier.

While liquidity mining gave projects another option for bootstrapping liquidity, it added a new issue — sustainability. How long can protocols maintain liquidity mining programs before the heavy issuance rates start to drag down their token prices? Fickle liquidity providers may also abandon their juicy rewards if volatility hits and their capital comes under risk. And large funds participating in systematic “yield farming” strategies have no allegiance to any specific protocol or hesitancy about dumping mined tokens as soon as they are earned.

Enter Tokemak.

Tokemak creates siloed pools of liquidity governed by the TOKE token holders to allow asset holders to direct single-sided liquidity to exchanges. Since protocols don’t need to pay a fee to use Tokemak, liquidity provision is sustainable. And since users provide single-sided liquidity to Tokemak, providing assets creates double the liquidity versus a direct pool of two tokens.

With Tokemak we push the efficient frontier beyond what was previously achievable and have once again expanded the opportunity set for protocols. This by itself is a great result, on par with the invention of liquidity mining.

But we’re not done yet with the extent of Tokemak’s reach. Not even close.

Protocols don’t need to let Tokemak have all the fun. Alchemix has already understood the power of the token reactor and realized it can support its own liquidity by incentivizing users to deposit to Tokemak. It went about creating a staking pool for Tokemak LP tokens (called tAssets) with a higher yield than Tokemak pays liquidity providers for ALCX tokens to incentivize even greater staking within Tokemak.

Alchemix also receives the TOKE rewards paid by Tokemak to LPs, which slashes the cost of receiving liquidity. In the Evolution of DAOs article, Once again, Tokemak estimates Alchemix will be able to reduce its mining emissions from around 86% per year to around 6%, a 93% reduction that saves Alchemix $130 million per year at current prices.

Some protocols may decide to take matters into their own hands to be completely sure liquidity never leaves when protocol users need it most. OlympusDAO’s Olympus Pro product allows protocols to re-purchase their own LP tokens from liquidity providers via bonds that sell at a small premium to the market in exchange for their native tokens. With Tokemak, they can instead repurchase tAssets, gaining the ability to ensure liquidity for their token without taking on any risk of impermanent loss, as they would have if they bought Pool 2 LP tokens. Owning their own liquidity via tAssets also entitles protocols to continued TOKE emission rewards from Tokemak which help offset further liquidity purchases in a virtuous cycle.

In case it wasn’t already obvious, the protocol owning the liquidity means they are no longer renting it! As the protocol continues to accrue its own liquidity, the cost it pays for liquidity gradually falls until it owns the entire circulating supply. At this point, the protocol has ensured deep, sustainable and reliable liquidity for its users, is paying nothing to have this, and is taking no impermanent loss risk.

But wait, anon. There’s one more step. While the protocol has already turned all circulating supply into liquidity, it can do the same with all minted supply. All treasury and escrowed/vesting assets can ultimately be provided into Tokemak, ensuring that every single outstanding token that a project possesses is paired with a collateral asset and providing liquidity in decentralized exchanges.

This is the ultimate result for protocols, creators, businesses, governments, or organizations desiring the electricity of Web3. Tokemak makes it possible.

Deep, sustainable liquidity will soon be available for all assets, and the importance of that alone makes the case for Tokemak-ximalism.