An answer to DeFi's cash flow problem? - Introducing Protocol Perpetual Rewards

 Web3 DeFi protocols have become an extremely efficient cash flow engine.

As these numbers have gotten larger, an important question has been advanced:

What happens to a protocols’ transaction fees?

Two of the most common answers to this question are:

1. They accrue to the governance-controlled treasury of the protocol and are deployed via governance mandates (grants, audits, etc.)

2. Depending on the protocol, they could be distributed to the protocols’ enablers. For example, the Uniswap smart contracts automatically distribute a portion of a transactions’ trading fees to the liquidity providers who help ensure a trades’ execution

There are many more examples of these two common answers working in practice, but a third avenue for such cash flow distribution, which has raised questions about securities law implications, is distributing a portion of the collected fees directly back to token holders.

Without an effective menu of ways that governance-controlled protocol treasuries can effectively deploy their war chests, value may be trapped inside of treasury stockpiles in perpetuity and thus unable to make its way to those responsible for creating value for the protocol in the first place.

Securities law topics are for lawyers, so I’m going to avoid discussing the topic entirely and instead propose a potential new avenue that protocols could explore. Before you read below, it is important to know that none of this is legal advice (or any type of advice for that matter) and the below is for theoretical discussion/narrative purposes only. No party should take this as any type of advice. Please consult your own attorney as to the viability of your plans and business decisions. Lastly, it's unclear if any idea below resolves any questions/issues pertaining to cash flow distribution and any resulting securities law implications, but at a minimum it could be a new angle for further exploration by teams.

Introducing perpetual rewards:

Taking the cash flow that would have gone to idle token holders and redirecting it as perpetual rewards for protocol users based on governance-curated distribution formulas.

Current Idea that is raising securities laws questions:
Transaction occurs → Portion of tx fees is forwarded to passive tokens holders

Potential New Idea below:
Transaction occurs → Tx fees are forwarded to the treasury → Governance vote to quantify and distribute governance rewards → Distribute accordingly

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1. Perpetual Rewards (PR) = Number of interactions w/ a protocol’s contracts (I) multiplied by the number of tokens held (H). 

(This formula, (PR=I*H), is iterative, customizable by protocol, and up to governance control).

• More nuances can be introduced to the formula for compliance reasons if required. For example, instead of “number of tokens held”, the H variable could be “number of tokens held and used in the last governance vote”. 

2. Funding comes from the treasury, given they’ll be collecting protocol transaction fees via business as usual processes (including fees that could have been disbursed to normal idle token holders).

3. All perpetual rewards are paid out of a single pool, set up and quantified by governance initiation/vote, and allocated pro rata to each user. For example, if there's $10,000,000 in fees available for rewards distribution over a given time period, and 1,000,000,000 aggregate “rewards units” to be claimed by all eligible users, a person who’s PR formula is 1,000,000 units would have claimable rewards of $10,000.

A few things of note:

1. If you’ve never used the protocol, the value for interactions will be 0 and as a result, no rewards will be claimable. This makes it clear that rewards are for users.

2. Compared to only distributing value to idle token holders, this value distribution methodology could be viewed as a more equitable split between protocol users and token holders -- really driving home the point economically that users are the owners of a protocol.

3. This methodology encourages people to use one wallet, helping to solve a growing problem in DeFi. 

Conclusion:

1. Creating tight value loops between users and networks is Web3’s mission. Therefore, it is important to keep exploring ways to make this happen while operating within various sovereign legal frameworks as required.

2. It remains to be seen if “rewarding” users based on both their holdings and usage levels is enough to satisfy legal and compliance questions that exist today for distributing a protocols’ cash flows.

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Daniel Zider,
daniel.g.zider@gmail.com

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