TL;DR: It’s time that Henry’s proposed Liquidity Tournament be put into motion as a component of the Penumbra protocol. It’s time to deepen the liquidity of the Penumbra shielded pool so that the premiere private trading experience can be first-in-class.
In this post, I want to outline what this rollout could look like and how this would concur with the software Penumbra Labs has been building to compliment their release of Veil, the premiere private trading experience for Penumbra. Explicitly, it is in response to the most important quality missing for Penumbra: deep, high-quality, and highly-available liquidity.
In this post, I’ll speak on:
- The state of Penumbra’s DEX, Veil, and the importance of Penumbra’s anonymity set
- The Liquidity Tournament Software
1. Focusing on Penumbra’s DEX, the Veil Trading Experience and the Long-Term Utility of the Anonymity Set
With Veil having launched, Penumbra Labs has continued building quality-of-life improvements. What the ecosystem lacks is a mechanism to attract users, and a key pillar for any DEX is sufficient protocol liquidity. Penumbra has taken @hdevalence’s insight in producing software meeting these requirements. Now that Veil is a premiere trading experience for private token swaps, the next priority is deepening protocol liquidity while improving its quality.
Using incentives built from the protocol itself is strategic. While reaching out to marketmakers throughout the cryptoeconomy could artificially inflate Penumbra’s activity, making Penumbra inherently useful long-term is far more advantageous for the ideal trading experience.
It’s crucial traders access not just available liquidity, but ‘high-quality’ liquidity—uniquely possible on Penumbra due to how it traverses the liquidity graph: liquidity of the highest quality (best pricing and availability) is the most likely to be used in executing transactions on the graph of available liquidity.
It is my understanding that Penumbra Labs has taken @hdevalence’s insight in producing software meeting these requirements, and I propose enacting it as part of the protocol.
The Current State of Penumbra’s DEX
Over the last year, Penumbra has undergone a constellation of engaged efforts to improve user experience. The focus on incrementally improving interaction software has paid off massively.
Penumbra now has a native private trading experience without user experience trade-offs. Considering the community initially had to eat glass to conduct private transactions—it’s time to deploy this UIP. Without liquidity covering what users expect from a trading experience, Penumbra’s DEX hasn’t truly been turned ‘on’—this UIP represents a meaningful step toward making the DEX a central network feature.
The Importance of a Working Shielded Pool
The Penumbra ecosystem expands by ensuring baseline privacy requirements are met. With a working Shielded Pool containing deep liquidity encouraging low-slippage trading, far more becomes possible. Trading is Penumbra’s first frontier; any cryptocurrency future requires an economy fueling transaction needs.
2. The Liquidity Tournament as a Tool for Improving Penumbra’s Private Trading Experience
By adopting the software that Penumbra Labs is developing for this purpose, we can now make this possible. By adopting the Liquidity Tournament software, LPs will be offered incentives for providing liquidity to the protocol, and delegators who have staked the UM token will be able to vote for which liquidity is most important to the chain.
The intent of the Liquidity Tournament should be two things:
- To deepen the available liquidity to trade with
- To increase the quality of the liquidity available
Henry outlines his rationale for how the Liquidity Tournament could be structured, but in practice the software emphasizes the involvement of those who stake UM to the protocol as the population who can vote each Epoch on which pairs should be prioritized for incentives.
Proposed Structure of Incentives and a plan for Rollout
I would propose that the Penumbra Liquidity Tournament software provide incentives earmarked from the Penumbra Community Pool in the amount of 1mUM (1 Million UM, or 1% of the total supply). Explicitly, this means that the UM earmarked for this purpose is not new issuance, but is instead coming from protocol-held liquidity that is already a part of the total supply to the network since Genesis.
As @hdevalence mentioned in his original post, the incentives should be:
- distributed first to delegators who perform the work of signaling what liquidity is high quality, then,
- to liquidity providers who provide the highest-quality liquidity used in trading on Penumbra and Veil.
As a recap, the liquidity offered these incentives would (initially) be on LP positions oriented toward anchoring UM as a core asset of the Penumbra ecosystem; since transacting on Penumbra is cheapest when using UM, it should act as a natural vector for swap transactions traversing the liquidity graph.
The plan behind how these incentives could be distributed would take place over the course of:
- A signaling proposal from the Penumbra community to engage in the Liquidity Tournament
- Several sequentially agreed-upon periods (Tranches) with a capped incentive amount, based on the Liquidity Tournament’s performance as an incentive mechanism
- Governance proposals submitted for ratification that would supply the Liquidity Tournament module with the funding necessary
Once necessary discussion has taken place outlining the intent of incorporating the Liquidity Tournament module into the protocol, I’d suggest an on-chain proposal be issued for ratification by delegators for Penumbra to take on a protocol software change incorporating the requirements of the Tournament.