Onchain Market Making for $LSK on Ethereum via Arrakis PALM

Proposals Funding
21

I want to inform the DAO that have updated the above proposal according the points mentioned in the Changelog (see at the top of the proposal) and in agreement with the proposed Lisk Treasury Council. I intend to run the voting after additional 2 weeks of discussion time. Looking forward to your feedback

1 Like
23

Not sure what you mean here, can you explain in more detail please?
Concerning the Budget, it is stated in a separate section, which is also explaining what the budget is used for.

25

Not sure what you are missing. This is the section I have been referring to: Onchain Market Making for $LSK on Ethereum via Arrakis PALM

27

It should be clearly stated separately.

You mean how much every member of the council receives?
The budget will be equally distributed among the members. Having 4 external members in the council and a budget of two thousand LSK means each member receives 500 LSK as financial compensation for the work in the council.
We can add this to the proposal if it provides more clarity.

28

Sorry, today has been a tough day
 It’s a nightmare, I’m looking at the book but understanding nothing
 :man_facepalming:

We need to add how much funding will be allocated from the DAO treasury for Arrakis(1M$ in LSK).

29

Greetings, Lisk DAO Community!

We extend our sincere appreciation to Arrakis for submitting an innovative and well-considered proposal to enhance $LSK liquidity through their Protocol Automated Liquidity Management (PALM) solution. Me and my team at @discere_tech have background as credit investors, we approach this analysis through a lens focused on risk-adjusted returns, transparency, and alignment of interests. Our goal is to empower this proposal with constructive insights—rather than present a negative critique—to support the Lisk DAO in optimizing its treasury management strategy. This memorandum provides a detailed evaluation of the PALM proposal, including a cost-benefit analysis, risk assessment, and actionable recommendations.

Executive Summary

The Arrakis PALM proposal requests a $1 million allocation of $LSK tokens to an automated liquidity management vault for the $LSK/$wETH trading pair on Uniswap V3 (0.3% fee tier). The strategy promises capital efficiency, reduced slippage, and sustainable liquidity without liquidity mining incentives. However, the proposal’s 50% performance fee on trading fees and 1% AUM fee significantly reduce net returns compared to the DAO managing liquidity independently. After a thorough cost-benefit analysis, self-management yields a higher net return ($442,300 vs. $263,750 annually under baseline assumptions), though it requires operational investment. We recommend approving the PALM proposal only with revised fee terms and robust risk controls, or pursuing self-management if the DAO can build sufficient expertise.

Proposal Overview

  • PALM Proposal: Allocate $1 million in $LSK to an Arrakis PALM vault, controlled by the Lisk Treasury Council via a 5-of-8 multisig wallet. PALM will algorithmically transition the initial 100% $LSK position to a 50/50 $LSK/$wETH ratio using organic trading activity, then maintain concentrated liquidity on Uniswap V3.

  • Self-Management Alternative: The DAO directly manages liquidity on Uniswap V3, retaining full control and avoiding external fees, but incurring operational costs.

Key Benefits

  1. Cost-Effective Liquidity Provision
  • PALM leverages organic trading volume, eliminating the need for $LSK emissions via liquidity mining, preserving token value and ownership.
  1. Enhanced Capital Efficiency
  • Uniswap V3’s concentrated liquidity, paired with PALM’s automation, maximizes depth with less capital than traditional pools.
  1. Transparency and Control
  • Funds remain in DAO custody via the multisig wallet, with on-chain transparency and withdrawal rights at any time.
  1. Improved Market Dynamics
  • Reduced slippage and price impact enhance the trading experience, potentially boosting $LSK adoption and volume.
  1. Strategic Liquidity Bootstrapping
  • Starting with $1 million in $LSK, PALM builds a balanced $LSK/$wETH pair, supporting both buy and sell activity.

Cost-Benefit Analysis

Below is a detailed comparison of the PALM proposal versus self-management, incorporating precise numerical estimates based on realistic assumptions.

Assumptions

  • Allocation: $1 million in $LSK.

  • Daily Trading Volume: $500,000 (annual volume: $182.5 million).

  • Uniswap V3 Fee Tier: 0.3% of trading volume.

  • Annual Trading Fees: $547,500 ($182.5M × 0.003).

  • DAO Team Costs (Self-Management): $100,000/year (one full-time equivalent).

  • Gas Fees (Self-Management): $5,200/year (weekly adjustments at $100 each).

PALM Proposal

  • Revenue:

    • Gross trading fees: $547,500.

    • Performance fee (50%): $273,750.

    • DAO’s share of fees: $273,750.

  • Costs:

    • AUM fee (1%): $10,000.

  • Net Return to DAO: $263,750 ($273,750 - $10,000).

Self-Management

  • Revenue:

    • Gross trading fees: $547,500.

  • Costs:

    • Team costs: $100,000.

    • Gas fees: $5,200.

  • Net Return to DAO: $442,300 ($547,500 - $105,200).

Comparison Summary

Metric Palm Proposal Self Managment
Gross Trading Fees $547,500 $547,500
Performance Fee (50%) $273,750 $0
AUM Fee (1%) $10,000 $0
Team Costs $0 $100,000
Gas Fees $0 $5,200
Net Return to DAO $263,750 $442,300
Difference - +$178,550

Insight: Self-management outperforms PALM by $178,550 annually, driven by the absence of the 50% performance fee, though it requires operational investment.

Sensitivity Analysis

  • Low Volume ($100,000 daily):

    • Gross fees: $109,500.

    • PALM net return: $44,750.

    • Self-management net return: $4,300 (costs exceed revenue).

  • High Volume ($1M daily):

    • Gross fees: $1,095,000.

    • PALM net return: $537,500.

    • Self-management net return: $989,800.

  • PALM Efficiency (+10% fees): Gross fees rise to $602,250; PALM net return becomes $291,125, still $151,175 below self-management ($442,300).

  • Higher DAO Costs ($150,000): Self-management net return drops to $392,300, reducing the gap to $128,550.

Conclusion: Self-management remains superior unless trading volume falls below $350,000 daily or DAO costs exceed $178,550 annually.

Risks and Mitigants

The proposal and self-management alternative present risks that require careful consideration and mitigation.

PALM Proposal Risks

  • High Performance Fee

    • Risk: The 50% fee significantly reduces DAO returns, especially at moderate volumes.

    • Mitigant: Negotiate a lower fee (e.g., 20-30%) or impose a hurdle rate (e.g., 5% return before fees).

  • Smart Contract Risk

    • Risk: Bugs or exploits in PALM contracts could lead to losses of the $1M allocation.

    • Mitigant: Require audits within the last 6 months and secure smart contract insurance.

  • Oracle Vulnerabilities

    • Risk: TWAP oracle manipulation could skew pricing and performance.

    • Mitigant: Leverage Uniswap V3’s 7-day TWAP and monitor for anomalies; explore additional oracles if needed.

  • Platform Dependency

    • Risk: Uniswap V3 governance or fee changes could disrupt the strategy.

    • Mitigant: Diversify liquidity across DEXs (e.g., SushiSwap, Curve).

  • Impermanent Loss (IL)

    • Risk: Price divergence between $LSK and $wETH could erode vault value.

    • Mitigant: Use PALM’s dynamic rebalancing and model IL under ±50% price scenarios to set risk limits.

Self-Management Risks

  • Human Error

    • Risk: Incorrect liquidity ranges or rebalancing could reduce returns.

    • Mitigant: Train or hire skilled liquidity managers and deploy automated monitoring tools.

  • Resource Drain

    • Risk: Managing liquidity diverts focus from strategic priorities.

    • Mitigant: Allocate dedicated resources or outsource to a DAO expert.

  • Scalability Limits

    • Risk: Manual adjustments may lag in volatile markets.

    • Mitigant: Establish data-driven protocols for rapid rebalancing.

Financial Considerations

Opportunity Cost

  • Holding $LSK: A 50% price increase yields $500,000 in unrealized gains.

  • Lending: 2-12% APY generates $20,000-$120,000 annually.

  • PALM: Net return of $263,750 (baseline).

  • Self-Management: Net return of $442,300 (baseline).

Insight: Self-management offers the highest direct return, though PALM’s automation could free resources for other opportunities.

Fee Structure

  • PALM: $10,000 AUM fee + 50% of trading fees.

  • Break-Even Volume: $6.67M annual volume ($20,000 / 0.003) to offset AUM fee.

  • Self-Management: $105,200 in operational costs, no external fees.

Insight: PALM’s fees require substantial volume to justify, while self-management scales better with returns.

Arrakis’s Track Record

  • Peak TVL: $1.83 billion (July 2022).

  • Current TVL: $143 million (April 2024).

  • Security: Audited by WatchPug and Sherlock, with active bug bounties.

Insight: Arrakis has a strong history, but recent performance data and audits are essential to confirm reliability.

Alignment with DAO Objectives

The proposal supports the DAO’s goal of enhancing $LSK liquidity on Ethereum, critical for Layer 2 adoption. However, high fees and risks must be managed to avoid undermining financial stability.

Recommendation

We recommend pursuing self-management unless PALM offers revised terms or demonstrates superior performance in a pilot test. If opting for PALM, the following steps are critical:

  1. Secure Updated Audits and Data
  • Require third-party audits (within 6 months) and detailed performance metrics from Arrakis.
  1. Refine Fee Terms
  • Negotiate a performance fee of 20-30% or a 5% hurdle rate to align incentives.
  1. Adopt Risk Management Measures
  • Diversify across DEXs and secure smart contract insurance.
  1. Run a Pilot Test
  • Allocate $250,000 to PALM and $250,000 to self-management for 3 months to compare real-world results.
  1. Build Self-Management Capacity
  • Assess DAO resources; if costs exceed $178,550 annually, reconsider PALM with revised terms.