Solving wNXM discount while maintaining reasonable MCR%

Governance Discussions Nexus Mutual Protocol Improvement Proposals
21

There have been some interesting suggestions in this thread and it’s great to see the community so engaged with a topic.

I agree that purchasing wNXM below book book value makes sense for the mutual, and would like to see this go to vote soon.

In terms of buying wNXM above book value, but below the bonding curve price, think how this would work. We buy 1 wNXM at say $120, and then we redeem it at the bonding curve for $150 worth of ETH. Seems great! But WE are the mutual. So when we redeem the NXM for ETH, we take the ETH from the pool… only to then put it straight back into the pool. So, the ETH in the pool has not changed at all. What’s different? The NXM that we redeemed was burned.

So by buying above book and below the bonding curve price, all you’re doing is a buyback and burn. But, you’re doing it ABOVE the value of the assets that NXM token “owns”, which makes no sense, you’re just destroying value.

When it comes to the issue of removing the ability to redeem through the bonding curve, this would be problematic for the tokenomics and also to our members. I tend to dislike changing the rules in the middle of the dance, and members bought our token with the idea that they would be able to redeem above 100% MCR. If we remove that, we’re screwing them. On the tokenomics side, without sell pressure NXM price on the bonding curve will get out of whack, so we’d need to adjust the formula, which seems unwise.

Some of the other suggestions include separate pools and bans on bots. These are overcomplicating the issue IMO. Allowing for a redemption queue would prevent most of these concerns, is easier to implement I believe and is already in governance (though never voted on).

I’d like to see us take the following to governance ASAP:

  1. Give the investment committee the power to purchase wNXM tokens on an on-going basis using the capital pool, when they believe that doing so will add value to the mutual.

  2. Create a queue system that would allow for redemption of NXM to ETH through the bonding curve, when MCR is above 100%.

This mandate would allow the committee to execute on the plans above, to remove wNXM from the market when below book value and to contribute to an LP to provide greater liquidity, or to burn if more liquidity is not necessary.

The 2nd is more complicated and would require some development work, but I do believe it’s necessary based on the communities response. Clearly, the current system feels unfair to members and that’s something that we should prioritize fixing IMO.

(edited $ number for above book value to represent updated valuation)

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22

You are buying wNXM at $60 but when you redeem it for $150 - you are essentially burning one NXM and returning the $150 to the pool. So you are now -$60 in the pool but also -1 NXM.

To illustrate what I mean - say you have 100 NXM (100 share of the pool) and the pool has $15,000. Each NXM in practice own $150 of that pool. Now you take $600 from the pool to purchase 10 wNXM, use the bridge to turn them into NXM. The pool then redeem these 10 NXM into $1,500* - you just burnt 10 NXM. Your pool now has exactly $14,400 (because you used $600 to purchase wNXM) and the community own 90 NXM - which represents a value of $160 per NXM.

So in fact you’ve increased the book value per NXM by purchasing and redeeming (burning) one NXM.

My only worry is that burning / redeeming the NXM purchased from the market will not necessarily impact the price because psychologically the market might not care about it. Buying back wNXM from the market and then supplying it as liquidity is effectively the same as burning the NXM (if the Mutual agree not to sell it back) but with the increased value of supplying liquidity (improving price discovery) and earning fees (increased the capital pool book value).

I was one of the first to seed the wNXM pool on Bancor and we worked with the community to approve LM rewards. I love the one sided pool, meaning that you don’t need to provide BNT + the IL protection. If we can work out a deal with the Bancor community to add LM rewards - we could earn fees + BNT to the capital pool while increasing liquidity - while effectively reducing the amount of NXM in the market. A win-win in my book.

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23

You’ve just described buying back below book value. Which we’ve already said is accretive. The problem is buying back ABOVE book value.

Your example is also incorrect because you’re assuming that $150 is the value of the NXM token. But it’s not, that’s just the price on the bonding curve. The value is the underlying assets that are owned by each of those tokens.

Which right now is: 162,425 ETH / 6,902,992 NXM = 0.0235 ETH per token = $99.88.

So if we’re purchasing wNXM at say $120, which is below the bonding curve price of around $150, you’re not creating value, you’re destroying it. Using a proper example you can see this:

Capital Pool = $684,867,590

Let’s spend $12,000,000 to buy 100,000 wNXM and redeem them.

Now the pool is $672,867,590 and we have 100,000 wNXM too.

So we redeem them through the bonding curve, essentially just burning them.

So the pool is $672,867,590 and the outstanding tokens goes down to 6,802,992.

That means the book value per token is now = $98.90 which is lower than the $99.88 from before.

That shows how we’ve destroyed value.

You can of course make the argument that $150 is a fair valuation and so we should be buying up until that point. Which is dangerous IMO, particularly since the market clearly does not agree with that valuation.

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24

@Dopeee - Apologies - I missed the above. I definitely think we should NOT buy any wNXM when it is above book value - that wouldn’t make sense.

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25

Let me just clarify that the intent of my original proposal was not to just buy above book and redeem at the bonding curve. It was to use excess ETH above 100% MCR to purchase wnxm and burn it instead of letting people arbitrage the difference.

My mind however has been changed because of the conversations in this thread. I think buying below book makes sense, as most people agree. But I think the wnxm purchased should be added as liquidity in uni v3 (or used for partnerships) instead of burned, and that selling to the bonding curve should be disabled. I don’t think buying above book makes sense, but instead our focus should be in raising the book value and increasing liquidity around book value in a way that incentivizes holding while also giving liquidity to those who must sell.

I’m happy to explain further in tomorrow’s call.

26

So cool we get to evolve our collective thinking here!

I do not see how liquidity is increased using uniswap. There is already plenty of liquidity in any DEX, in particular BANCOR.

Nothing wrong with selling to the bonding curve once that is possible.

I love the actions suggested by @Dopeee

To conclude: as with any investment, the investment commitee should just use the capital pool how they see fit, nothing else needs to change on the dynamics currently in place. (item 1)
If someone wants to sell, there is the (item 2) proposed queue system from that is funded with a mechanism we come up with.

27

Current liquidity in Bancor is $12m. For larger funds/investors, it’s not enough to deploy meaningful size.

Concerning the “buying $wNXM, redeeming on the bonding curve”, I think we are overcomplicating things. Summary : buy $wNXM → sell on the bonding curve if liquidity → result : burned $wNXM, $ETH leaves the pool → $ETH re-enters the pool.

If we want to burn, why wouldn’t we just buy $wNXM → send to burn address? It would reduce complexity and unknowns.

Very dangerous and a bad signal in my opinion. We could achieve the same thing by simply reducing artificially the MCR% below 100. For example by holding an investment at 0 value.

28

Great community call today - was nice to see this idea discussed in an open forum. I wanted to say one thing as we begin the next phase of ‘research’ on this. While the OTC / one person buying ideas are practical in getting this rolling, they are not long term solutions in my opinion. Yes, this will lead to the fund buying back wNXM and, yes, it will send the appropriate message to the market, but it lacks scalability, efficiency, and isn’t truly decentralized.

I know dev resources are a bit constrained at the moment, but what about beginning to design a contract where there is:

  • Some deposited ETH (surplus given the current coverage)
  • An oracle on wNXM price
  • A calc function for the book value
  • And an automated exchange ratio of ETH<>wNXM

Thus, we have this contract that is automated and decentralized, which will buy wNXM as long as the price is below the ‘book value / unit’ price. The onus would be placed on traders / arbitrageurs to find wNXM on the open market (even at centralized exchanges like Binance), buy it there, and then bring it to the redemption portal to exchange for ETH. In this case, we don’t have to rely on community members buying it OTC or from exchanges - rather, profiteers will come to the mutual looking to sell their wNXM.

There are some limitations to this idea:

  • Introduces smart contract risk
  • Will still be some deviation from full book value due to gas costs / oracle costs

Let me know what you think about this broad outline for a decentralized way to conduct the buybacks.

29

Just chiming in here from the Bancor side. Current $wNXM in the pool is roughly ~100K:

image

there is free space for another ~18K of $wNXM available in the $wNXM pool:

image

the co-investment from the Bancor side on this pool is ~1M $BNT at the moment. The Bancor DAO with a high probability will more than likely vote in favor to increase the co-investment limit in this pool to open up single-sided capacity if the mutual is considering staking a portion of their treasury funds. There is a precedent from the Bancor side in increasing the co-investment limits for other projects that have similarly deposited a portion of their treasuries.

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30

I think generally everyone can agree that purchasing wNXM below book value is a no brainer, I would favour a general commitment to recurrent buys any time wNXM trades below book rather than a one time purchase.

I also think providing liquidity with purchased wNXM either with a book to bonding curve range on Univ3 or via Bancor is a great idea and would be a much better option rather than a burn.

As far as purchasing above book value, as a general rule I would be against it but I can definitely see the virtue in capturing the arb. Maintaining the MCR at 99%~ by holding some assets at 0 value until the discount is reduced seems like a more reasonable option but I haven’t considered all the implications.

Regarding suggestions for a queue system, I’m a little wary, if it was possible to exit through the bonding curve in a reliable fashion then any rational actor is incentivised to do so as soon as possible in order to capture the premium between NXM and wNXM. This would encourage people to enter the queue and as a result hold their NXM rather than staking it.

Such a system would no doubt please some members but I believe it would have limited benefit to the mutual as a whole and isn’t worth diverting developer time.

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31

I like the idea of holding an investment at 0 value or similar to enable the mutual to retain the investment returns rather than the bots. I’m also in favour of buying Wnxm upto book value.

If a pot of eth can be sent to a multisig that can then be used to buyback at discretion rather than telegraphing and thus combine the 2 then that would be perfect.

I also have a good friend who works at GSR in London if/when discussing with them a role in the buyback is deemed interesting.

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32

Is the idea to eventually just hold the wNXM in here?

Very good point actually, we want people to keep staking.

Reading some further comments, there seems to be some confusion here. We are trying to have the mutual benefit from the discounted wNXM below book value, bots are not part of the problem as they exist in any market, it seems a few people are a bit salty about them. I know Yannick is running a bot and was told they are bloody expensive to code (took almost a year for them to appear - imagine how much coding that is at what opportunity cost of not working), run (has to run on powerfull and fast intrastructure) and maintain. Bots actually help to maintain a price between platforms (e.g. CEX and DEX). Sure no one would complain once he start actually buying NXM and increase the value (arb when wNXM is higher) :slight_smile:

Let us focus on the buybacks and let the rest of the market play out, we don’t want to introduce new scenarios, complexities and risks.

It is fully up to the investment committee how they want to increase returns based on the buybacks.

33

I think this is a very good approach. Eth can be shuffled from the capital pool as needed to keep the pool slightly below the MCR floor yet still sufficient to meet our cover liabilities.

What if we closed the loop and add that the contract will sell all it’s wnxm at 5% below the MCR floor and the mutual can then call back all the ETH into the capital pool once we are trading above the MCR.

That way the contract is clearly a temporary intervention that is only activated when wnxm trades crazy low and it naturally closes out when wNXM tracks NXM on the bonding curve. From the capital pool perspective it is ETH in and ETH out so it should hopefully be only small adjustments to the core contract.

It also clearly limits the exposure the capital pool has to buying wNXM so reduces attack vectors. This is the best idea I’ve seen so far for fixing this problem.

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34

First of all, this thread shows how active our community is on solving this issue. There have been many great points and suggestions within this thread, but I will summarise some of the main points from the Mutant Meetup call where the wNXM discount was discussion. For those of your who weren’t able to join the call, you can listen to the recording here.

Buying wNXM below book value. Everyone in the community agrees that buying wNXM while it’s trading below book value is the logical move. However, there are several issues that make a buyback somewhat complicated:

  1. Limited liquidity within DeFi. The deepest liquidity for wNXM is currently on Bancor. For a buyback to be effective, the mutual would need to use ~2% of the Capital Pool to conduct a buyback. Using the current holdings (162,406 ETH), 2% is equal to 3,248.12 ETH ($13,890,260.37) at current prices. On Bancor, there is currently $12,394,366 of liquidity within the pool.
  2. Deepest liquidity is available on CEX (Binance). Conducting a buyback within DeFi would likely take several months to make enough trades without incurring significant slippage. If the mutual were able to send ETH to a CEX such as Binance and have their OTC desk conduct a trade, we could conduct a buyback within a short amount of time. However, at some point, a single person would be required to transfer the wNXM back to the Capital Pool. More details and discussion can be heard on this week’s Mutant Meetup call.
  3. Tax advice for the Mutual. Hugh spoke on the call about the tax advice, which the mutual has received and is reviewing before presenting to the wider community. Conducting trades using capital pool funds could be delayed until there is more clarity on the tax implications.

Buying back wNXM when it trades below bonding curve price. A few members of the Investment Hub weighed in, as did Hugh, on this point. The bonding curve is used to control capitalisation levels, and book value differs from the bonding curve price. Buying wNXM back up to the current bonding curve price would require the mutual to buy wNXM above book value, which wouldn’t deliver value to the members of the mutual. There’s wider discussion on this as well.

Buying back wNXM and burning it? Or buying back wNXM and providing liquidity on Uniswap V3? The discussion touched on two points. Buying back wNXM and burning it keeps the corresponding ETH in the pool. When wNXM is redeemed for ETH, it is burned, so burning wNXM effectively keeps ETH in the capital pool. However, other members brought up the issue of low liquidity for wNXM within DeFi. Buying back wNXM and providing liquidity in a concentrated range above book value up to the bonding curve price would establish a price floor going forward and provide deeper liquidity for wNXM in DeFi.

Solving for the arbitrage issue as MCR% rises above 100%. If a wNXM buyback occurs and the mutual’s investments continue to grow, the cashflows (in addition to cover buys) will push the MCR% above 100%. With bots arbing the profits away, it’s unlikely that the mutual can grow the capital in the pool. There were several possible approaches to solve for this issue, which included:

Disabling NXM sells on the bonding curve. Potentially resuming MCR growth slowly over time. The Investment Hub advised against this approach and shared that it would be received poorly by the market. Hugh also pointed out that any modification to the mutual’s smart contracts introduces more risk. There was a discussion about slowly resuming MCR growth by possibly no more than 10% annually to retain profits in the capital pool and grow the size of the pool over time. Other ideas were presented on the call and above in the comments on this post.

Given this summary, the community could use the conclusions reached in this discussion to further research the most effective way forward.

If a buyback were conducted, would selling ETH for wNXM on a CEX like Binance using an OTC desk be an issue for members?

If wNXM is bought back using capital pool funds, should the mutual burn the wNXM or provide liquidity in a concentrated range on Uniswap V3?

How can the mutual prevent bots from arbing away investment earnings and profits from the capital pool in the longer term?

We can discuss these points and any others regarding the wNXM discount, possible buyback and strategy, and the use of funds if a buyback were conducted.

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35

One point I have a relatively strong opinion on. I don’t think we should be changing the smart contracts to deal with the arb issue. If you take ETH out of the pool on a semi-regular basis this prevents MCR% going above 100%, so the arb issue goes away simply by implementing other aspects of this.

Secondly, I suggest implementation should be done manually for now, eg via the Community Fund multi-sig. If the process is successful and members wish to set-up something more permanent then we can look to automate in the future. Getting V2 out has higher priority and any automated approach would be very complicated given current liquidity in the various markets. In short, it would be a big dev distraction.

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36

I don’t think we are trying to solve the arbitrage, which by itself is not an issue, but looking at how can we profit from the discount on wNXM right? A very different thing.

There will always be arbitrage in any markets. It’s not for us to ‘solve’. If for example we use Binance it’s also gonna be arbitraged in the DEXes to even out the price, with even higher profits to the bots as we are talking big amounts. So let’s please just ignore that aspect, it’s painful yes but very normal in any market.

The problem originally outlined and solution to that is to buy the discount on wNXM below book value. This can be done by the investment committee, just like any other asset. And everyone could benefit from that.

Edit: so rather calling it a problem this is just an investment opportunity, simply put.

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37

I don’t understand the bot issue at all. Bots represent human impetus; after all, some human or humans designed the bots. The bots simply execute the human desires.

At some point, the humans will turn off the bots. That point will be when enough people have sold all they want to sell and now desire to hold NXM for future price appreciation into the bonding curve.

In other words, the bot non-issue will be solved when NXM is a more attractive investment.

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38

In such a situation, when both alternatives have their merit, I like following the good old advice of an experienced actuary: Do Half.

And thank you for your summary of the main points of the call, which helps bring structure to this thread as well!

39

I hear Hugh’s point about doing this manually so devs can focus on v2. I am happy with that approach but another idea would be to have external devs build a stand alone buyback contract. Use the community fund multisig to put ETH in and get wNXM out in tranches and pay the devs with a grant up front or an ongoing commission.

I loved the point raised on the community call (made by Dopeee I think) of “I want the mutual to do this trade, not just signal it and have the price adjust” - the strategy above wouldn’t be as good as manually using the OTC desks at achieving that goal, but it would serve a slow and steady approach. Perhaps it would be a strategy for the community fund instead of the capital pool. As Hugh mentioned on the call, they have different objectives.

Yes, I think the upside of capturing a deep discount on wNXM is worth the risk of having do some manual trades. I would prefer to see a decentralised approach like a stand alone buyback contract but I would rather see the mutual buy back below book than not.

I would rather see it burned - the sooner the bonding curve is the go to place to buy and sell NXM the better it will be for all mutual members. Having deeper liquidity in wNXM is good for people wanting to buy in cheaply, having an MCR higher than the floor is good for all the current mutual holders.

I do like the idea of the community fund providing liquidity - it would generate some revenue for the fund - perhaps converting the LDO rewards into ETH and staking it in specific uniswap ranges would be an easy win?

I liked the idea of an immediate action being to start the MCR floor rising slowly again - this would keep the value from cover buys and investment returns in the mutual. This would reduce the (small) buy pressure in wnxm from the arb bots and give the investment team more time to buy back at a big discount. Ultimately the way to stop the arb is lift the MCR%. Buy and burn the wNXM until it is above book value is a good first step and gives us time to think about the longer term strategy.

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40

There are still some serious risks we need to consider, for example now with the CREAM hack. 7+ million USD of wNXM can be sold on the market crushing the price, wNXM price might still remain low and the Mutual can be left as a bagholder, not even be able to sell if we used the funds from the capital pool. There is no guarantee wNXM price will go higher even with buybacks.

There is also a risk to LP, the permanent loss might be significant if the provided ETH will be used to swap for wNXM, digging an even deeper hole.

For those reasons, we should not be touching the existing model, existing capital pool and only use the surplus earned from investments such as stETH to buy wNXM below book.