SPO Liquidity Bonds

Optim’s SPO Liquidity Bonds will allow SPOs to borrow liquidity to bootstrap ADA delegation during the early stages of stake pool operation. While a number of factors determine the economics of stake pool operations, the largest determinant of block production and thus rewards is delegation. This creates the biggest barrier to entry when spinning up a new stake pool, as operators need to bootstrap enough delegation to mint blocks consistently, prove operational proficiency, achieve competitive APR, and then leverage this through marketing and community building into a sustainable pool.

Interest & Duration

Any stake pool that needs delegation can pay what we expect to be around 1.5% interest for a 1 Year / 1 million ADA bond. We are exploring shorter and longer duration bonds based on SPO feedback (3, 6, 18 months). The interest rates will be fixed and predetermined for each bond. The interest for each bond is paid upfront, but released incrementally over the course of the bond to the lender.

Bond buyers (lenders) receive the staking rewards for the pool of the SPO bond issuer the same way as any other delegator. Staking rewards go directly to lender wallets via stake keys, with predetermined fixed and variable fees going to the SPO. Additional ADA interest that is prepaid in the Liquidity Bond smart contract is incrementally released to the lender every 6 epochs over the course of the loan. The combination of normal staking rewards and interest paid for the bond comprise the total APY for bond buyers.

While the minimum bond size will be 1 million ADA, users will be able to pool funds into single 1MM ADA bonds for execution. The minimum bond size was calculated based on the amount of stake necessary for SPOs to mint blocks consistently and the amount of ADA in a pool required to get ROA (return on ADA) close to 3%. When combined with the additional interest paid by an SPO, lenders receive at or above market competitive returns.

Product Goals

In order to be successful it is imperative for SPOs to recognize Liquidity Bonds for their intended purpose, a marketing tool. We’ve spoken to many Operators while conducting research and there’s full consensus that any temporary delegation campaign, whether it is these Liquidity Bonds, rotating IOG/Cardano Foundation delegation or participation in a protocol’s ISO, is not enough to retain delegators for the long term without a concurrent marketing push to establish organic growth. An SPO Liquidity Bonds is simply a tool to make that process easier.

Eventually, the need to keep these bonds will decrease over the life cycle of the pool. SPO Liquidity Bonds could become a business expenditure that is more reliable than investing into marketing campaigns alone and can help supplement a pool’s marketing and community building efforts.

Canceling a Bond

Bond cancellations are possible, with SPO bond issuers able to cancel at any time and lenders able to cancel only if the preset ROA (return on ADA) performance threshold is not met. The incremental disbursement of prepaid interest to lenders allows for a bond cancellation without an SPO losing all their prepaid interest.

Lender Cancellation

A lender’s interest, beyond the prepaid 1.5%, is dependent upon stake pool performance. For this reason, there must be a mechanism by which a loan can be canceled if an SPO is performing poorly and driving down the ROA of a bond buyer. Our smart contracts have been designed to track the actual staking ROA in a given pool, disregarding both the Margin and Fixed Fee parameters individually. This allows the pool operators to adjust any parameter to ensure the minimum return threshold to the delegating ‘lender’ is met, thus not exposing their bonds to lender cancellation.

The exact calculation of the performance threshold or ‘liquidation parameter’ that enables lenders to cancel is still under consideration, but will be well-defined and known for all bonds prior to their issuance. A small pre-determined penalty paid to the lender will be incurred by the SPO borrower in the case of a bond cancellation/liquidation by a lender.

We’re currently running simulations and backtesting on data from every stake pool from 1–1.5MM ADA to calculate what metric indicates unjustifiably poor return performance. The importance of the luck factor is large and sometimes SPOs see 5–6 epochs where no blocks are minted. Thus simply taking an 8 epoch period and calculating if ROA is above 2% is not sufficient. The ROA threshold will also adjust and decrease proportionally along with Cardano treasury rewards paid to pool operators.

Borrower Cancellation

SPO bond issuers can cancel a liquidity bond at any time for any reason. However, there will be a penalty for doing so. We are still exploring what constitutes an appropriate penalty at different points during the lifecycle of a bond. Our intention is to cover the costs associated with onboarding stake pools to our system before permissionless bond issuance is enabled. We must also consider the inconvenience and any lost returns incurred by lenders, though we expect this to be minimal.

IOG Parameter Changes

One of the most important and discussed topics among SPOs are possible incoming changes to the stake pool Fixed Fee parameter. Currently, all stake pools have a hard coded floor set at 340 ADA per epoch. While this is meant to cover the operation cost of running a stake pool, this parameter has not changed since the Shelley hard fork in 2020, back when the price of ADA was a fraction of what it is now.

This presents a limiting factor to small pool operators, as the fixed fee unintentionally eats up a majority of the staking rewards when SPOs are only minting one block per epoch, which is often the case among the small pool demographic. This makes it harder to present a competitive ROA to potential delegators, and some Operators have gone as far as manually returning some of these rewards back to their delegators.

The debate has centered around how low the new fixed fee should be, as well as how this will impact small, medium and large pools. In order to account for this potential change, our smart contracts have been designed to track the actual staking ROA in a given pool, disregarding both the Margin and Fixed Fee parameters individually. This allows the pool operators to adjust any parameter to ensure the minimum return threshold to the delegating ‘lender’ is met, thus not exposing their bonds to lender cancellation.

Vision For the Future

As the Cardano ecosystem grows, tooling improves, and infrastructure is built, we expect that our Liquidity Bonds will move further towards a fully permissionless market that fosters the growth of quality SPOs. By aligning incentives and introducing a market mechanism to stake delegation we hope to improve the performance of the Cardano blockchain as a whole. Directing capital to those inclined to use it wisely, furthering decentralization via competitive ROA for small pools, and improving yields for ADA holders are all achievable aims as the community continues to grow and support DeFi.




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