Will Tezos Have A New Liquidity Pair For Liquidity Baking After The Next Protocol Upgrade?

by | Dec 14, 2021 | Governance, Latest, Liquidity Baking, Opinion

In this piece, Allen Walters explores Liquidity Baking on Tezos, past protocol upgrades featuring liquidity baking, and the potential for the liquidity baking pair to be changed in the future.

Image courtesy of the Tezos.com Illustration Library.

The Last Upgrade And Liquidity Baking

During the last protocol upgrade, we’ve seen the true democratic nature of the on-chain governance mechanism in Tezos. After the Hangzhou proposal was injected and open for voting, a second proposal was injected, which only differed on one subject: the liquidity baking pair. 

A quick recap on two of the main concepts in this event:

Decentralized Governance

An important problem to solve in the evolution of a running blockchain is the ability to upgrade the blockchain protocol smooth and fast, without compromising decentralization.

How can we upgrade the blockchain’s core protocol in such a way that no central entity controls the evolution of the blockchain? Tezos has solved this issue by implementing on-chain governance.

Proposals can be injected through the governance process and all token holders have voting rights. Holders of XTZ that do not run a node and produce blocks, can delegate their voting rights to the ones that do. This way, the process is democratized.

Liquidity baking

XTZ News previously covered Liquidity Baking before it was launched and you can read part one here and part two here.

In short: Liquidity Baking is a single-pair, semi-protocol-level, decentralized exchange. So one trading pair, not part of any of the DEXes on Tezos. A unique concept.

Liquidity Baking (LB) provides a Subsidy for liquidity providers which will be paid in XTZ. Due to this subsidy, it is worthwhile to add liquidity to the XTZ – tzBTC pair.

The XTZ that is needed for the subsidy is created by the protocol. Especially when liquidity is low, the subsidy rewards will be a lot higher than the staking rewards that people can earn by baking, or delegating.

By design, the incentive to add liquidity to the Liquidity Baking pool is extremely high when liquidity is low (Over 2,000% yearly ROI when the amount of XTZ is around 0.1 million), and moves toward ~6% (similar to staking rewards minus inflation) once it reaches ~43.8 million XTZ.

Liquidity Baking was introduced and activated in the seventh protocol upgrade “Granada”.

Hangzhou 

“Hangzhou” has just gone live and was the eight protocol upgrade that was approved on the Tezos blockchain since mainnet went live close to 4 years ago.

Tezos has been the fastest evolving decentralized blockchain that is currently live and has improved its transaction capacity (tps) several times, lowered transaction costs several times and increased the level of complexity of smart contracts.

It has also enabled privacy-preserving transactions through Sapling, added the Tickets feature, enabled liquidity baking, halved block time along with numerous other protocol optimizations.

The Hangzhou proposal included a continuation of Liquidity Baking. Not everyone within the Tezos community thought the trading pair in the Granada Liquidity Baking model was ideal.

tzBTC is wrapped Bitcoin on the Tezos blockchain. It can be obtained through decentralized exchanges on Tezos, but the circulating supply is supplemented through institutions which creates an obstacle for independent minting of more tzBTC. The choice for BTC as part of the trading pair has been part of discussions. 

And thus, as can be expected in a true democracy, another option was presented during the Hangzhou vote: Hangzhou II which included the full Hangzhou proposal plus a modification of the Liquidity Baking contract from XTZ-tzBTC to XTZ-USDtz.

In previous governance rounds there have been multiple options too, but the main proposal always won by large majority. In the Hangzhou vote, the outcome was close (around 50-50 for several days) and in the end the original proposal that included the XTZ-tzBTC pair won with a 55% majority. 

Next protocol upgrade

There is clearly an interest to potentially change the Liquidity Baking pair. The XTZ-USDtz proposal was injected late during the proposal phase and only a few days of voting was left and still the results were almost at a tie.

Around one billion delegated XTZ voted for the proposal. The Hangzhou proposal phase had the highest participation rate of any proposal vote period since Babylon over two years ago and it was the closest vote in tezos history.

A stablecoin might be an interesting choice. It would increase liquidity of the stablecoin and with that the value stabilization of the dollar peg.

Tezos has several stablecoins with different designs. Some USD-backed and some XTZ-backed. It will be interesting to see if there will be other pairs proposed in the next protocol upgrade.

USDtz will be proposed, that is a given, and Kevin Mehrabi will campaign for the USDtz option.

The question is, will uUSD, cTEZ, kUSD or WTZ take a shot too? 

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