Tokenomics Proposal: Replacing the Bonding Curve

Introduction

The purpose of this forum post is to establish community consensus on the proposed tokenomics mechanism & begin a discussion on parameterisation.

So far, the discussion has been ongoing in the #tokenomics-revamp Discord channel and individual interactions amongst stakeholders.

Work has been focussed on the mechanism and associated modelling described in Nexus Mutual Tokenomics Proposal - Design v1.3, with the latest version of the model itself available on Github.

NB: The stochastic scenario modelling section at the very end of the document is due to be filled in next week.

Out of Scope

Please do not discuss the following topics on this forum post and keep discussion focussed on the buying/selling mechanism. If you’d like to propose anything related to the following topics, please create a separate thread.

Anything to do with MCR other than removing the floor is out of scope - should be a separate upcoming project.

For now, any additional capital attraction mechanisms are also out of scope.

Mechanism Tl;dr

This is a brief summary of the buying & selling design proposed in Nexus Mutual Tokenomics Proposal - Design v1.3. For full detail please see the document.

  • The MCR floor is removed & MCR is driven by Cover Amount going forward.
  • Every time there is a buy on the protocol, the price goes up
  • Every time there is a sale on the protocol, the price goes down
  • This is achieved via a notional Uniswap v2 pool, with the mutual itself as the only liquidity provider
  • There is a target liquidity in ETH in the pool - if the pool is below this liquidity, additional liquidity is provided to the pool (subject to an MCR limit). If there is an excess, it is withdrawn.
  • Buying NXM from the protocol is disabled below book value to avoid dilution of members’ book value
  • Selling NXM to the protocol is disabled above book value to avoid dilution of members’ book value
  • Instead there is a ‘ratchet’ mechanism that moves the protocol NXM price towards book value over time from below and above

Key discussion points

From my perspective, these are the things we should agree on as a community when it comes to this proposal moving forward.

  • There is a balance to be struck between retaining capital in the pool and providing exit liquidity to members who want it
  • The proposed mechanism is a reasonable, working way to achieve this
  • How much liquidity roughly should we be injecting on an ongoing basis into the pool to allow members to exit?

If we agree on these points, we can move forward towards parameterisation of the mechanism, and I will set up a separate forum post if it makes sense to do so.

High-level Timeline in 2023

Below is a timeline from my perspective going forward, provided there is agreement on the mechanism. As always, way more important to be thorough and ensure code & mechanism is rock-solid rather than shipping something with holes in it.

Q1 Feedback on mechanism and parameter discussion. If no major red flags and nothing significant needs to be redesigned, engineering work begins to convert tokenomics spec to solidity code after v2 is live.

Q2 Code finalised, appropriate testing, audits.

Q3/Q4 Governance process, New mechanism live.

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Great work Rei, so happy to see this go public. I know the huge amount of work that has gone into this proposal and I’m excited for you. You did an amazing job.

I think it would be helpful if you could list out some of the pro’s and con’s of this mechanism. There are going to be tradeoffs and likely most people will not read the full document. It might be useful to just briefly bullet point what the upside of this mechanism is and what downsides we are trading off.

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The impossibility to redeem tokens and the artificially high price of the NXM token in the Nexus platform has made impossible to attract new buys/new capital and has put a huge downward pressure in the wMXM token, because the only way to leave the platform was through wNXM. This has caused the trade of NXM to basically stop, and that wNXM has ended trading at around 30% of its book value (currently 50%). This also reflects very poorly in the mutual as a whole. Therefore a new mechanism to move the parameters of the system to a more reasonable situation is urgently needed.

However I disagree with this approach of replacing the bonding curve, because in my opinion the problem is not the bonding curve in itself, but instead the MCRfloor, which is an artificial value, and it is not based on any mutual needs. The intention of this parameter is to be a calculation of actual mutual needs, and based on existing covers, the MCR would be much lower, and the system could be operating in a much healthier way if the capital pool was closer to the actual needs of the mutual. Among other things, buys and redemptions would be allowed.

It is clear that suddenly replacing MCRfloor by a more reasonable value like Active Covers/Gearing Ratio would cause a price shock that is undesirable. But I propose a solution in which the price of MCR calculated as Max (MCRfloor, Active Covers/Gearing ratio) would be replaced by MCR = Active Covers / Gearing ratio + f(t), f(t) being a function that has a very high value at t=0 and tends to 0 at an arbitrarily slow rate. Thus the calculation of MCR would move from MCRfloor to Active Covers/Gearing ratio at an arbitrarily slow pace.

In my opinion, this solution would be much simpler to define and to implement, and the resulting operation of the mutual, including the pricing mechanism and the redemption process would be kept in line with the description included in the Nexus Mutual White Paper.

Furthermore I think that the solution proposed by the tokenomics group would add significantly complexity to the system, the outcome is more difficult to predict, and it may not achieve its goals of enabling redemptions for members who want to leave the mutual. It also has some practical disadvantages:

The ratchet mechanism above book value would cause that in the absence of a constant buying pressure of the NXM or wNXM tokens, the token price would be dragged down to book value, making it more difficult for the mutual to achieve a market cap defined by the mutuals’s performance.

The sizing of the liquidity pool and the refilling rate would be a limit on how much capital can leave the mutual in any period of time. If this pool and/or this rate are too big, the token price would be dragged to book value strongly, if it they are not big enough, not enough people who want to exit would be able to do it is a reasonable time, which again will put downward pressure on the wNXM token.

The middle ground would be not allowing all redemptions but many of them and pushing token price to book value but not very strongly, although constantly.

Longer and more detailed discussions are taking place in the tokenomics-revamp channel of the discord server, and I suggest that any vote about the future redeeming process of the mutual includes both the option to retain the bonding curve and to replace it with some other alternative like the proposal of the tokenomics group.

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There’s many problems with what this mechanism would do to the book value of the mutual.

Any new system implemented here should be one which can exist for many years, and which will work under all market conditions. The main concern I have with the current bonding curve is that we should not be be allowing members to exchange NXM for ETH at a price above the book value of the mutual.

Insurance is very unique, it’s not equivalent to other industries. The largest insurers market caps are driven primarily by their book value. The same should be true for Nexus Mutual. The main difference is that while the shares of a public insurer trade in public and are swapped between different investors, this system we’re talking about here is specifically the mutual buying and selling the tokens i.e. doing a “buyback” or “issuing shares” in the traditional markets. For insurance, where book value is the driver of market cap, a company would only want to do a buyback when the shares are trading below book value and issue new shares when trading above book value.

In contrast, Apple trades not on book value, but on perceived future income, asset value etc. So, they would use a buyback either when they believe that the market value is below this “true value” which is calculated using a variety of factors. In insurance, it’s more simple, you can basically just use book value and generally negate the other factors (for example, many billion dollar insurers trade on stock markets below their book value for decades at a time, this is common and normal.)

The other reason to do a buyback in traditional markets is because it’s a tax efficient way to redistribute capital, when compared to issuing dividends. The same is true here for Nexus Mutual.

So, any tokenomics system which will be involving us buying and issuing NXM should be treated in terms of whether or not it will maximize book value.

Any system which involves the mutual buying NXM from members and giving them ETH for a price above the book value of the mutual will actively degrade our book value. This is a problem because book value should be the way that the success of Nexus Mutual is actually judged. Also, when you do this you’re giving liquidity above book value to people who are wanting to leave their investment in the mutual, while degrading book value for those remaining. The result is that you’re actively punishing those members who are long term aligned and still believe in the investment. It will literally create a race condition, whereby you see that everyone selling into this mechanism is destroying book value, so you know that if you stay your book value will be worse tomorrow than it is today, so you should also exit. Then, you get a race to the exit among rationale actors, massively degrading book value for those remaining.

This is obviously a bad situation and no long-term aligned party who was an investment timeline longer than a year would want this to happen.

That same logic is why the bonding curve right now is also bad. Which is why it needs to be removed. Members should only ever be able to exit the mutual at book value. If we believe that we have excess capital and wish to use that, we should not be using that to buy NXM from members at an arbitrary price dictated by a bonding curve. We should be using it to buy wNXM from the market below book value, and burning it, to increase book value so that members then exit at a higher price because book value is higher.

Rei’s proposal is nice in that it allows members to have liquidity, so people can leave if they want to. But, they cannot leave at a price which will actively hurt those who want to stay. The only way to do that is to allow members to only leave at around book value.

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in the following website that I’m posting below, you can take a look at the share buybacks that Allianz has done in the last few years. As I am sure you know, Allianz is a giant in the insurance business, and I am sure that you know as well that a share buyback implies buying shares of the company in the stock market with their own capital pool. Since Allianz is trading above book value, as opposed to Nexus, it means that any buyback reduces the book value per share. It includes details of the current existing program and of all of the past buybacks, which in total amount to more than $10B since 2017.

https://www.allianz.com/en/investor_relations/share/share-buy-back.html

I guess this fact absolutely and completely invalidates your premise that in the insurance business, buybacks only happen below book value. And also your other comment that in the insurance business, the book value is the correct measure of success, because if that was the case, there would be no explanation for one of the biggest insurance companies in the world to use this tool, which reduces book value.

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I also said:

I don’t find the argument that X large insurer did this, so that’s automatically a good approach and we should replicate it. Allianz trades at a little premium to their book value, as do some other large insurers, particularly if they have valuable consumer facing auto / home / health policies with access to consumers directly.

They also hold a large amount of real estate and have a large asset management business. So, it’s not obvious to me that you can say that Nexus Mutual is in a similar position to Allianz, and that we should just copy what they are doing.

Clearly, they believe that their business is undervalued, or, they are just treating this as an efficient way to distribute excess capital beyond their typical dividend.

Fairly confident that you’ve made comments before asking whether the mutual should dissolve, which would mean releasing capital at book value. You can’t have it both ways, you can’t say that the mutual should dissolve and release capital and that we believe that our true value is greater than book value, and so should buy shares above book.

By making the argument that we should be releasing capital, in any form at all, you’re making the argument that the mutual cannot use the capital more efficiently in the business, and so should instead release it back to investors. If that’s the case, given how small our outstanding exposure is, how can you simultaneously believe that we should say true value is above book value? What insurer with less than $200m in exposure is worth more than book value, when it’s not printed massive YoY growth?

It’s pretty obvious to me personally that the fair true value of Nexus Mutual right now is not significantly above book value. If and when we begin to grow our exposure and increase profitability, that true value should rise by accruing profits and driving book value up. But also, by deserving a premium to book value, because we’ve shown strong growth that justifies paying above book. At which point, if you can predict strong profitable growth going forwards, you can make an argument that we should programatically be buying tokens above current book value. But we are not there today.

To be clear, because I’m anticipating that this will be spun, I’m not suggesting that the value of Nexus Mutual today is ONLY the assets we hold. I’m suggesting that it’s not significantly above that, to the point where we should permanently introduce a tokenomics system which will blindly buyback tokens far above book value, when there are countless other factors that should dictate whether this is a good idea or not.

Once your system is in place, we would need to believe that there is not ever a situation where the mutual should only ever be valued as a function of outstanding cover, which seems obviously to be untrue. Your argument is that book value cannot be used solely to decide whether to buy tokens at a value, but instead, your system uses only cover outstanding to decide…

Imagine a scenario where the market is aware that enormous claims are upcoming, but they are not yet filed. In which case, the true value of the protocol should likely be below the book value at that time, as in this example there’s a belief that 20-30% of the assets will actually be paid out in claims shortly, and then revenue will also drop because with less assets our other policies must shrink. Clearly, just using cover outstanding to programatically buy back tokens from the market here is horrible. Not only do we take a big loss on the claims, but we double down by then buying tokens from the market programatically at an excess value. Whereas a rationale operator would halt any buybacks at that point, reassess based on the new asset value and cover sales post-claims, and decide what the new value for buybacks should be.

Rei’s system has a similar flaw, but has the benefit of having a ratcheting system which goes down. So, when the market incorporates this information into wNXM, sells will come direct to Nexus Mutual, and the price ratchets down to reflect the sell pressure so that we aren’t paying so much in excess of the new perceived “true value”.

Should also note I didn’t say that every insurer trades at or below book. I said that book value drives the market cap, which is broadly true. Depending on niche you might find that property insurers are closer to 2-2.5 P/B, while life insurers very often less than 0.8 P/B. That’s a function of profitability, growing market segments and less efficient policy pricing.

Keep in mind, you’re also only look at the largest, most profitable insurers in the industry. Nexus Mutual was unprofitable in 2022 and has 1/10,000 of the assets of Allianz. They are not even remotely comparable.

When you look at more comparable insurers, P/B is a better measure.

If you’re going to look at one of the most profitable insurers, with diversified risks, an extremely strong brand, a real estate and AM business and a unique access to customers, no, P/B is not a measure that you can rely very strongly on for whether to do a buyback or not.

Your suggested system is completely blind to the factors which would dictate whether an insurer should be valued at a premium to book value, yet it automates issuing of new tokens and buyback of existing tokens. Instead, Rei’s system which automates this but only at around book value prevents this system from taking massively suboptimal actions.

If we wish to do larger buybacks, above book value, we can do that manually via vote if and when we choose.

In our current position, we can likely execute fairly significant buybacks purely one-off, by buying wNXM on the market. There is no need to incorporate this directly into the tokenomics, which will exist for years going forward. We are on the same page with regards to doing a buyback right now. Yes, we should do that, at the right price, which is the current wNXM market price. I disagree that this needs to be programatically forced into the tokenomics, because under many scenarios it becomes net negative.

I’m anticipating that your response to this will spinoff into whether the mutual should dissolve or not. If it does, I’d kindly request that you do that in a separate thread. Your post here is about whether we should use your proposed tokenomics, let’s keep it focused on that only.

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Thanks Dopeee.

A pros/cons list for my proposal as I see it:

Pros:

  • Unlocks capital pool for member exits
  • Pulls price up towards book value (“BV”) over time if sufficient liquidity is provided
  • Closes wNXM/NXM gap, and therefore makes NXM price used in protocol for covers/claims market-consistent
  • Book value increases as a result of each buy/sell by definition
  • The mutual can be a price-setter or price-taker depending on parameterisation, including having different positions above and below BV. For example, we can provide high liquidity for exits to set a strong price floor, but have low target liquidity in the pool above BV to closely follow the market.

Cons:

  • Redemptions from protocol disabled above BV and buying NXM from protocol disabled below BV, so capital only removed/captured through sells/buys in those ranges. Note that members can still enter/exit through wNXM and wrapping/unwrapping.
  • Price anchoring to book value from above, although can be tempered by parameterisation.

A comment on the timeline, as been getting lots of feedback on that - aim is to have something live around mid-year, but could be delayed by the amount of engineering effort required, gas cost optimisation, audit availability, etc.

Will provide thoughts with the appropriate amount of detail on the alternative proposal & discussion above after the weekend.

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Well, many points to make:

  • First thing, important one: You keep talking about “my” proposal. And it is not mine, it is Hugh Karp’s and Reinis Melbardis’. They wrote a white paper with it, and built Nexus Mutual in its image. And under this proposal is under which all of the token holders who ever bought NXM token in the Nexus Platform bought from and into. Everybody bought at Market price (market price, not book value) as defined by the bonding curve, and the ones who sold, sold to the mutual at market price (not book value) minus a spread. So it is important to keep in mind that I am not proposing any change, in fact I am proposing to keep the design as it was defined in the first place, planned and implemented.
  • It is absurd to discuss with anybody who continuously moves the goal posts. First it was, “buying above book value makes no sense, nobody would do that”, and I said that buybacks do exactly that. Then it was that “ok, but only companies like Apple would do it, because they are valued differently, but no insurers”, and I said that Allianz does, and now it comes that “ok, but Allianz is not an insurer that Nexus can compare itself with”. How much further away are the goal posts going to go?
  • By the way, Allianz also distributes dividends, on top of performing stock buybacks, so it is not as if they do buybacks because it is more tax efficient. They just decide to reward shareholders in both ways. REWARD shareholders, because buybacks are a way to reward shareholders that stay, despite reducing book value, and despite using the capital pool to buy shares from members who are leaving.
  • I am also not asking that we copy that they do, I am suggesting that we do, what we always did.
  • The comment (singular, one, I have only made one comment about it) that I have made about the mutual dissolving, was that if a large majority of the mutual token holders wants to remove their capital, the mutual should liquidate. And it is a common sense statement: The capital belong to the members of the mutual, and if they express a majority opinion on the mutual stopping operations, the mutual should do that. If there was a vote and 51% of the holders vote to close the mutual down, I certainly hope that nobody opposes that. Note that that does not express my opinion about whether I personally think, or not, that the mutual should dissolve.
  • I am definitely making the statement that the mutual cannot use the capital more efficiently in the business. And this is based on the fact that a) Active covers have rarely exceeded 200k ETH since August 2021. Currently 116k ETH. This should be underwritten with something like ~42k ETH, leaving an excess capital of ~110k ETH. b) Investment activities of the mutual so far have been a net negative for the mutual: More ETH has been lost than earned. Under these circumstances, the best use of the capital pool is returning it to the mutual members. How can I say that “true value” is higher than book value? It is obviously not right now, but if book value would be reduced, and the capital was used efficiently, capital returns would be positive, and “true” value (whatever “true value” means, I mean market price in the end) would be above book value. It is ok to think that the mutual can use capital efficiently, unfortunately the reality is what it is. Facts are not opinions, and nexus has never used the capital pool efficiently, so far.
  • You said that nexus right now is not worth significantly more than book value, and that “when we begin to grow our exposure and increase profitability, that true value should rise”. This is true, but the exposure seems to be going down, has been for some time indeed. And you know which is the other way to increase profitability? Reduce capital. So well done, you are in the right track there. What is a way to reduce capital? Give it to shareholders.
  • “once your system is in place”. “My” system is in place. Rei’s proposal would replace it. The rest of that sentence seem to imply that the current market price is based on the book value, but it isn’t. Again, facts are not opinions. wNXM price is based on what the market values it, and it is not book value, it is 50% of that. NXM price is based on what the bonding curve values the mutual. Book value is a parameter used by the bonding curve to calculate token price, but so is MCRfloor. And the result of the bonding curve with MCRfloor is not book value, it is ~40% more than that. The bonding curve would value NXM higher than now, with a smaller capital pool, if only MCR was calculated accurately and not kept artificially high.
  • You keep on focused on the mutual buying tokens above book value, apparently still convinced that this is bad by default, despite the points of buybacks being positive for shareholders, and the need to reduce capital to improve profitability, and I have to wonder if you know how the mutual used to work: buy tokens, and selling tokens, were always open, and both happened at market prices. In fact, redeeming NXM tokens was (and is) exposed to a 2.5% redemption fee. This redemption encourages users to wrap the NXM token and sell wNXM outside the Nexus platform. Which results in the capital pool not leaving the mutual, but the mutual member being able to leave at market price, above book value. Which is a win-win-win situation. In the end there would be an equilibrium where there may be NXM token redemptions, but also token sales which would happen at market price, not book value, would replace the capital lost in the capital pool, and wNXM and NXM would be trading at more or less the same level. This was the case until the price of NXM was kept artificially high, and wNXM decoupled from it.
  • My best guess is that you are only able to see the situation in which somebody buys wNXM tokens now, unwraps and sells NXM for ETH. Since that means buy below BV and selling above BV, there’ll be some profit for whoever does it, you assume that the mutual is on the losing end of that trade. And it is basically not understanding anything, or seeing the relation between cause and effect: wNXM has become so cheap because Nexus is so unprofitable and the capital pool is unused and locked. And getting rid of the excess capital will make it more profitable, which in turn will make the mutual more valuable. And the profit that this person will be having is not at the expense of the mutual, the person who is losing here is whomever bought NXM on the platform, got desperate, wrapped it and sold wNXM below book value. The mutual and their members will profit from this, despite the smaller size of the capital pool.
  • I would have a few other things to say, but I am going to stop here, I’ve written long enough. My bottom line is that I want to keep the existing system in place, removing artificial limits, so that the mutual can operate as defined in the white paper. The bonding curve explained there is adequate for the mutual and it would fit its mission of redeeming excess capital when it is abundant, and attracting capital when it is needed. All this by increasing or reducing the token price that the mutual offers. This would increase the token price even if book value per token decreases, it would allow anybody who wants to leave, to do it at market prices, and the mutual would be smaller but way more capital efficient and more profitable. All in all, a clear net positive for the mutual, the holders that want to leave and the ones that want to stay.
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Thanks Rei.

A pros/cons list for the alternative proposal as I see it:

Pros:

  • Unlocks capital pool for member exits
  • Pulls price up towards book value (“BV”) and beyond
  • Closes wNXM/NXM gap, and therefore makes NXM price used in protocol for covers/claims market-consistent
  • The price of NXM/wNXM would trade relatively freely around a value that is determined by the mutual, based on its own financing needs and capital resources
  • The redemption fee would encourage members to exit by wrapping the token and selling it outside of the platform. Furthermore the redemption fee would be an additional income source for the mutual.
  • This proposal should be very easy to implement, and would keep most of the existing structure of the mutual in place.
  • The mutual would become much leaner, more capital efficient and more profitable

Cons:

  • Book value decreases
  • The size of the capital pool will be dependent on how many people want to redeem their tokens and at which level it will stabilize is uncertain. In any case it would remain a fraction of the current amount.

Honestly I cannot think of any more cons, but if anybody else can provide any reasonable ones, I would add them here.

Not sure why you insist on being so consistently rude.

I’ve put a lot of time and effort into trying to have a good discussion here and come to the right decision.

I’m not actively trying to move the goal posts. Originally we were talking about today, right now for Nexus, where I said we should only buyback below book. Then you brought up Allianz where I’m saying they might be able to justify buying slightly above book. Then, I brought up Apple, where book value plays very little in their valuation and so they can justify a buyback far above that. Those are all different situations and have different answers.

I’m happy to have conversations with those with different opinions. It’s good for the mutual to consider all the options. But, I have no desire to continue to be insulted. I’m happy to continue discussing if you change your mind on talking with me, and can be polite.

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Please take the time to be kind and respectful to other members you are speaking with. Everyone is just trying to acheive consensus and debate ideas.

If you are frustrated with another member, you are free to not engage with them or to simply not comment.

This discussion, like all discussions within the mutual, is about the free and open exchange of ideas. It’s not appropriate to insult other members.

Throughout this conversation, you have been aggressive and have repeatedly insulted @Dopeee. I’m giving you a warning, as your last comment was over the line. I’ve included it below.

This violated the Treat everyone with respect and the zero-tolerance policy on harrassment that we have for our community forums.

Instead of banning you here, I’m issuing a warning and asking you to limit your comments to the discussion of ideas and to refrain from demeaning comments or ad hominem attacks on other members.

Going forward, I’ll have no choice but to ban you if you cannot abide by these community guidelines.

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This is also about hyping executive compensation via share buybacks…irrelevant to this discussion. Tokens are NOT equity, incentives are NOT the same as share markets…just let this line of thinking die…

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