Cryptocurrency analyst. Founder and editor at btcpeers.com
There are lots of positives to take away from the ongoing DeFi renaissance. For one, the emergence of this concept has brought about truly liberating financial infrastructures designed to deploy user-centric solutions. With the help of DeFi, developers look to enable new paradigms in the financial sector, which hopes to strip away the input of intermediate service providers in banking processes. Fortunately, this unique approach to banking and related concepts has begun to catch the eye of industry participants. As such, it is no surprise that the DeFI landscape has attracted unprecedented coverage, with the assets locked in decentralized finance protocols registering exponential growth in just a short period.
After taking an objecting look at the success of this sector, I discovered that it has a lot to do with the flexibility embodied in decentralization. Before the advent of DeFi, developers had to check a plethora of boxes and pay exorbitant listing fees to improve market visibility and liquidity. It is common knowledge that the centralized exchange model limits the development cycle of crypto projects. In contrast, decentralized exchange services like UniSwap provide cheap and efficient ways to fund new projects as there are no unnecessary charges nor do they impose bogus conditions. As a result, developers can generate the required level of liquidity and ensure that their tokens organically upgrade from low to mid-market capitalization.
However, as it is with all innovations, there are drawbacks. Illicit entities can take advantage of the flexible nature of DeFI liquidity models to scam unsuspecting investors. It is difficult to impose market standards in the DeFi ecosystem. Hence, anyone can conjure new tokens, create and deposit assets in a liquidity pool, attract investors, and subsequently withdraw their assets prematurely once the price of the DeFI token increases. This scam, popularly called “Rug Pull,” is one of the major concerns of investors and developers as it threatens to stifle the growth of the DeFI landscape.
Take the recent SushiSwap scandal as a case study. In what seems to be an ill-advised move, Chef Nomi, the anonymous founder of this project, suddenly liquidated his share of the Sushi/ETH liquidity pool, worth $13 million, without consulting the project’s community. Consequently, this singular act caused the value of the token to fall by over 50%. Incidents like this embody the risk present in the DeFI market as a result of fraudulent or irrational decisions on the part of market makers.
In response to this challenge, a few crypto projects have opted to identify ways to ensure that the market retains its legitimacy, protect the interests of all market participants, and flush out bad actors. One of the solutions in this niche is Liquidity Dividends Protocol (LID). This project utilizes an enhanced locked liquidity protocol to eliminate losses due to “rug pull” scams on UniSwap. The protocol implements smart contracts that lock liquidity protocols for a specified timeframe to ascertain that the DeFi ecosystem maintains a trustless and transparent mode of operation. In other words, no one, not even the developers, is allowed to prematurely withdraw funds deposited in liquidity pools integral to the value of DeFi tokens.
Details about this solution also indicate that it functions as a certification protocol for DeFi projects. Having explored all of the functionalities of LID, I decided to reach out to the CEO of the project, Carlsbad Sunshine, and to get his perspective on the risks associated with liquidity in the DeFi market and how LID is working on eliminating them. Below is an excerpt from the interview.
Andrey Sergeenkov: Thanks again for accepting to share your viewpoint on DeFI’s recurring liquidity issues. Can you please introduce yourself and tell us why you are dedicating your time, resources, and expertise to the DeFI sector?
Carlsbad Sunshine: I’m Carlsbad, lead dev at LID. My work is an implementation of my research on lemons in capital markets. The Lemon problem was first discovered by George Akerlof in the 1970s. Essentially, the problem is that under certain circumstances, markets become inefficient because of “Lemons” or products that are unexpectedly low quality. Lemons plague the DeFi space, which not only causes investors to lose money, it also crowds out quality projects which can’t compete with the scams.
Andrey Sergeenkov: At the beginning of the year, did you project that DeFI will become the heart of the crypto movement?
Carlsbad Sunshine: Actually, I thought that new protections for users would be in place first before the DeFi boom. There’s a huge demand for access to financial services that surprised most of us. On the one hand, its amazing that DeFi has uncovered this huge untapped market. On the other hand, I’m worried about the ecosystem’s sustainability until better decentralized protocols for protecting users are built.
Andrey Sergeenkov: Unsurprisingly, the DeFI landscape has come under lots of scrutinies, considering that the progress made thus far has been truly remarkable. However, do you believe that it is fair to condemn the legitimacy of this growth because some flaws expose users and investors to risks?
Carlsbad Sunshine: No one is forced to participate in DeFi, and users are fully aware of the risks. Most people globally have limited access to financial services and sophisticated financial products, and opening these up makes a huge difference in many people’s lives. That said, we as a community need to step up and take responsibility by building products that protect people.
Andrey Sergeenkov: What is your thought on the recent SushiSwap scandal? Does this incident exemplify the risks associated with DeFi protocols?
Carlsbad Sunshine: It’s funny how SushiSwap is called “DeFi” when just one person was able to destroy the entire ecosystem. That doesn’t sound very decentralized to me! It’s exactly the issue plaguing many DeFi products. Without proper product design, smart contracts, and locking, there’s no accountability for project devs. Without that accountability, they can claim it’s decentralized while secretly holding the keys to the kingdom. We need to demand better.
Andrey Sergeenkov: Following the explosion of “rug pull” scams, do you think that the DeFi sector needs a kind of standardization system?
Carlsbad Sunshine: Standardization is one of the solutions to solving Lemon Markets, because standardization helps users understand, compare, and contrast different products. LID for instance uses a very straightforward form of liquidity locking where the locked liquidity is sent directly to the burn address. This needs to become the standard for liquidity locking, because it easily allows users (and products built on top of Uniswap) to display how much liquidity is locked for users to compare. Unfortunately, most competitors to LID don’t meet this high standard of liquidity locking, and have had loss of liquidity as a result. Without standardization, anyone can claim to lock liquidity while completely faking it.
Andrey Sergeenkov: What is the most viable solution to protect developers and investors from the loopholes inherent in DeFI liquidity models?
Carlsbad Sunshine: Send the LP tokens to the burn address. Do it trustlessly when the project launches. Do it without any custodian or third party. Any other solution opens up hidden risks. If the liquidity locking doesn’t have these three things, users will get an unpleasant surprise. We’ve fully open sourced LID’s code, so anyone can fork it if they want to do liquidity locking correctly. There’s no excuse.
Andrey Sergeenkov: From what I have learned about LID, it provides an enhanced version of the locked liquidity protocols often used to eliminate “rug pull” scams. Can you tell us more about the project’s advancements?
Carlsbad Sunshine: The primary advancement is making liquidity locking occur trustlessly at the exact moment the ILO presale ends. Projects that launch on LID first do an ILO through a dapp, where anyone can deposit ETH. But before the team or users can withdraw any tokens, the raised ETH and tokens must be permanently locked as liquidity through a button anyone can call. No one else is using this technology, older liquidity locking projects require a trusted third party to lock the liquidity.
Andrey Sergeenkov: How do you ensure that this process remains trustless and non-custodial?
Carlsbad Sunshine: Smart contracts that fully manage the entire process. When dealing with millions of dollars, faking it doesn’t cut it. LID does not give the team any latitude or power in the ILO, it's completely and fully operated by the smart contract. When a LID ILO runs, it is completely impossible for any tokens to be withdrawn until the liquidity has been locked.
Andrey Sergeenkov: There are minimum requirements imposed on projects intending to utilize LID for presale campaigns. What are these requirements?
Carlsbad Sunshine: We require 95% of tokens to be held in locking contracts or by the public. 60% of eth raised must be locked as liquidity, and 15% is set aside for post-ILO buyback and burns. The token contract must either be standardized or audited to make sure there’s no backdoors to steal liquidity. We also require some basic information about the project. However, we do not vet our projects on a deep level, and users of our ILO dapps should always carefully research the project.
Andrey Sergeenkov: The LID protocol also allows developers to initiate referral programs to boost the outcome of presale campaigns. How does this work?
Carlsbad Sunshine: There’s a 2.5% referral fee which is charged to all ILO depositors. This referral fee goes to the account which referred the depositor. It’s been a great way for the community to be rewarded for spreading the news about the ILO.
Andrey Sergeenkov: How many presales have you launched so far and how did they perform?
Carlsbad Sunshine: Including our own, we’ve launched 5 ILO presales. Every single time, the liquidity was trustlessly locked in Uniswap. All of those projects are still up and available to trade on Uniswap today.
Andrey Sergeenkov: In what seems to be a cascade of liquidity enhancement features, LID also offers certification to locked liquidity tokens. Would you care to explain this unique concept?
Carlsbad Sunshine: Our LID certificate is still under development, and would allow other dapps to verify the locked liquidity for projects which launched a LID ILO presale. A great example of this use case is AskoLend, a new lending platform which uses tiered lending for low marketcap tokens. Because these tokens rug pull frequently, AskoLend needs a hard liquidity guarantee to prevent insolvency.
Andrey Sergeenkov: At the moment, LID focuses on bringing added fraud-resistant offerings to UniSwap users. Are there plans to expand the scope of your operations in the future?
Carlsbad Sunshine: Yes, we’ve got a lot undercover that’s not quite ready for public release yet. But in general terms, there’s two horizontal directions to expand to improve fraud resistance. First, before the ILO, making sure users have better information and transparency in the projects they’re interested in. Second, after the ILO, keeping accountability from the ILO team to the community.
Andrey Sergeenkov: As per the information gathered about your project, LID is community-driven and has a unique governance model. What are the intricacies of the LID DAO governance model?
Carlsbad Sunshine: LID has a very strong business model where fees from ILOs go directly to the treasury. LID stakers get access to this treasury by voting on proposals to the Lid Dao. The Lid Dao is committee based, with 3 primary committees: Technology, Marketing, and Operations. These committees submit a monthly budget to the Lid Dao, which then approves or amends these budgets. Any remaining funds can be issued as rewards to Lid Stakers, or used to buyback and burn LID tokens from Uniswap.
Andrey Sergeenkov: Where do you see DeFI in the next couple of years, and do you think that the copy and paste culture of the DeFI community will come back to hurt its efficacy?
Carlsbad Sunshine: Right now, we’re in the early hype phase of DeFi. Its an exciting time where the community is discovering which models work and which won’t. For LID, we’re taking a longer term perspective that extends beyond the hype cycle. Unlike most DeFi projects, we have substantial revenue from ILOs, and after the DeFi hype ends that process will continue.
On the copypasta culture, well that’s often how innovation proceeds. People invent something new, then others copy it and try to optimize it. It’s a good process, but with the Lemon problems in DeFi, its making it very easy for scammers to hide out. The DeFi community needs to stand up to scammers and demand higher quality from projects. We need true decentralization, real trustless technology, and strong protections for users.
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