The Rift Protocol Explained
Rift is a decentralized protocol that restructures incentives to improve liquidity across DeFi. Today, we’ve updated our Gitbook to give an in-depth look into the fundamentals of the Rift Protocol and the smart contracts powering it. This post shares a high-level overview of the Rift docs.
Rift has created a novel form of protocol-owned liquidity that empowers DAOs to achieve sustainable liquidity in a single transaction, without needing to give up ownership of their governance tokens. We recently shared how Fantom and UniLend took control of their token liquidity by utilizing V1 of the Rift Protocol. This beta allowed our partners to control up to 32% of their liquidity on Ethereum DEXs while still retaining ownership of their governance tokens.
Since then, the team has developed V2 of the Rift protocol, creating a perpetual and durable protocol that abstracts away the complexities of participating in DEXs for both sides.
Rift unlocks deepened token liquidity for DAOs and grants Liquidity Providers (LPs) double the returns and protection against downside impermanent loss.
Are you wondering how this is possible, anon?
Current State of Liquidity for DAOs
Achieving significant liquidity remains a major pain point for tokenized DAOs. Poor token liquidity leads to a vicious cycle of token volatility, deterring new community members from joining with high entrance costs and little incentive to participate.
Current liquidity structures exacerbate the issue further. They drain treasuries and shrink market caps. The most common solution today, pool 2 liquidity mining, forces DAOs to deplete their treasuries to mercenary capital that yield farm projects to extinction. Both the size and value of DAO treasuries decrease as a result because these mercenary liquidity providers are profit motivated, rather than being community-focused and aligned with the long-term success of the DAO. These solutions are unsustainable and put these DAOs at great financial risk.
New frontier of DAO growth: Unlocked ✅
Enter the Rift
DAOs use the Rift protocol to deepen token liquidity without having to give up ownership of their tokens like they do with liquidity mining.
DAOs deposit their tokens into a Rift Vault. These tokens are paired with ETH deposited by liquidity providers and deposited in a DEX to deepen liquidity for the pair. Token pairs remain activated on DEXs until either liquidity providers or DAOs withdraw their tokens and positions are rebalanced.
Amplifying returns and reducing risk for LPs
Liquidity providers use the Rift protocol to double their returns and protect themselves from the downside risk of impermanent loss.
LPs can deposit ETH into any vault containing DAO tokens on Rift. This ETH is paired with governance tokens deposited by the DAOs then activated as liquidity in DEXs.
All swap fees from the DEX LP position, in excess of impermanent loss, are shared between the ETH depositors. This allows them to earn 2x rewards while only providing 50% of the capital for the position.
For LPs, depositing into a Rift Vault is strictly more profitable and less risky than depositing liquidity into the DEX directly.
Synergistic Partnership
The Rift Vaults are perpetual. They operate on an epoch-based system to prevent known DEX attacks like front-running. Upon withdrawal, returns are distributed to both sides according to the rules below. Any deposits that are not withdrawn remain in the DEX as activated liquidity for the pair.
Rift Vaults implement an interest rate floor for the ETH side of the Vault, mitigating the risk of impermanent loss for liquidity providers. Additionally, it implements an interest rate ceiling for the DAO side – so that any yield in excess of the ceiling is used to attract LPs.
Through the Rift protocol, the return profiles for participants are radically different from participating directly in DEXs.
- The ETH side gets back at least their floor.
- The DAO side gets at most their ceiling.
- The ETH side gets any additional yield beyond requirements (1) and (2).
Therefore, if yield exceeds impermanent loss, LPs take on the impermanent loss but still profit. If the impermanent loss exceeds yield, DAOs take on the impermanent loss.
Still with me, anon? Let’s dive deeper.
The standard impermanent loss return profile for the Uniswap V2 curve is outlined below.
The x-axis is the price ratio change from its initial values. So, where x=1, the relative price of the tokens has remained the same. Where x=2, the value of the second token has doubled relative to the first. Where x=0.5, the value of the second token has halved relative to the first (or, doubled in the opposite direction). These calculations are the worst-case scenario. This assumes that there are zero swap fees and zero incentive rewards throughout the duration of the deposit so that the only factor determining returns is impermanent loss (which is never positive).
Dive into our Gitbook for more in-depth coverage of the math.
To further illustrate the divergence in risk and return profiles on Rift, this graph below displays the standard impermanent loss profile for a Uniswap position (blue line) against that of an LP who deposits via Rift (orange line). As we can see, Rift LPs receive impermanent loss protection.
What happens if the DAO token price increases relative to ETH? The ratio of assets in the pool will have been skewed such that there are now fewer DAO tokens and more ETH in the LP position. In this scenario, the excess ETH in the position is swapped for governance tokens to pay back the DAO and make their position whole, never going below the LPs initial deposit.
What happens if the DAO token price decreases relative to ETH? The ratio of assets in the pool will have been skewed such that there are now more DAO tokens and fewer ETH in the LP position. In this scenario, the excess governance tokens are swapped for ETH to make the liquidity providers whole.
Adding the return profile for DAOs:
This graph and calculations assume there are no swap fees or other rewards. However, if swap fees outweigh IL, excess ETH is retained as profits for Rift LPs.
You’ve entered the Rift now. We’re glad to have you, anon.
Join the Rift
By rethinking the incentives behind liquidity provisioning, Rift unlocks a new frontier of DAO growth. DAOs can now deploy the governance tokens to significantly deepen their liquidity on DEXs without having to give up ownership of their tokens and mercenary farmers have the opportunity to earn double rewards and reduce their risk of impermanent loss.
Hungry for more? To learn about mechanics and dive into the smart contracts powering the protocol, check out the Rift Gitbook. The team will also be open-sourcing the Rift protocol smart contracts soon in preparation for our next announcement 👀