Foundation picking favorites by deploying liquidity - a mistake

General
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The Algorand Foundation decided to deploy liquidity into Dapps which at first sounds like a nice idea. But instead of spreading their ALGOs they picked 3 Dapps and just deployed liquidity into them.

“The Foundation has deployed 36MM ALGO to Algorand native Lending Markets, Options Vaults, and Algo / gAlgo liquidity via Folks Finance, Algo Rai and Pact.”

They are making multiple mistakes that way:

  1. Picking Favorites among Dapps. If the Foundation starts deciding on what Dapp makes it they are acting more like a government and additionally telling devs who think about coming to Algorand that people might prefer other protocols because the foundation helps them out more. Not an open market.

  2. Disincentivizing supplying ALGO on Folks Finance. It is normal that the borrow APR on FF rises pretty high towards the end of the sign up period, but this incentivizes new people and new ALGOs coming in. It’s not too bad having a high borrow APR on ALGO as long as it only lasts for a few days, which was always the case. But why exactly should one now supply ALGO to folks when the foundation is keeping the borrow APR and in that way the supply APR low?

  3. Deploying liquidity into a liquidity pool that doesnt need it. gALGO-ALGO had already a high TVL and the efficiency of the stableswap on Pact means it doesnt need more. Instead of deploying USDC, BTC or ETH liquidity on Algorand they picked one that doesnt really help anyone besides giving a protocol more TVL.

  4. Giving the “ALGO is a security statement” more fuel. The Algorand Foundation decides at will which Dapp to help out by injecting more ALGOs, especially without a governance vote.

  5. Promoting Folks Finance Governance leverage product without mentioning risks for the users and explaining they only will have 7 days to redeem their gALGOs (1-1). So if the Foundation can decide to inject liquidity at will they can also withdraw when they want to which means the borrow APR could rise again. They said they will monitor it but what if not enough new ALGOs come in such that they can remove their ALGOs? It’s stuck from now on?

Twitter post by AF: https://twitter.com/AlgoFoundation/status/1649084992738283520

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reply by the CEO of Folks Finance: https://twitter.com/BenedettoBio/status/1649106577436049432

When it took months to get this approved, why not make it a governance vote? What are the reasons and values? Why is that all happening behind closed doors?

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Thanks for sharing your concerns.

Daniel Oon wrote the following on Twitter to address those concerns:

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thanks for linking it in here! while i appreciate the fast response i dont think these are sufficient reasons:

  1. AlgoRai: the only reson seems to be VCs invested in it which sounds like a pretty bad reason. does AlgoRai have a liquidity problem? why is there a problem?

  2. Folks Finance: yes over 10% borrow APR sounds bad at first, but this also happened the last periods and was a great way to get new people and new ALGOs into the lending market. the high borrow APR was always a temporary problem. additionally, it seems like the foundation thinks this is a temporary injection which is wrong. they apparently injected 30M ALGOs and only 10M ALGOs are available to borrow… this means at least 20M are stuck for now. the biggest problem might be how much they helped out with compared to the amounts supplied on Folks Finance in general. They have ~60% of the total TVL of their lending market (not counting gALGO because it cant be borrowed). That sounds like way too much and makes FF very dependent on the foundation to function

  3. Pact: there seems to be a misunderstanding in how stableswaps work. they are highly efficient and the TVL/volume ratio is not as important here. additionally, they earn now trading fees which could have gone to people supplying liquidity on there which are not the foundation

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I am thinking that the idea here is that gALGO is so heavily entwined in the ecosystem now that it would be in everyone’s interest to have more liquidity to stabilize the markets. While I see your points, I liked Oysterpack’s response to this in kimchi’s twitter thread. While I was surprised at the methodology as I wasn’t aware this was something AF had intention of doing, it makes sense given the explosive growth Folks and Pact are experiencing as demonstrated via defillama. Without this extra liquidity, given the numbers we are seeing now with only a few hours left to commit, many might be scared off from trying defi commits, which AF supports and governors have repeatedly voted to support as well.

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GM @lobo,

Potentially 2 points here: (1) should Foundation deploy a portion of it’s treasury into Algorand DeFi at all and (2), if so, what Dapps should be selected?

On (2), the scope now has been limited to Dapps where we can improve liquidity w/o exposing treasury to obvious impermanent loss (eg. no Algo / BTC LP) or liquidation (eg. no borrow / lend USDT - Algo) risks. There may be further deployments we can make that fit this, but it does filter out a majority of possibilities straight off the bat.

There also may be good arguments for a wider scope and less caution in future, but that can be up for debate and better assessed once the effects of what’s been done are observed.

A big motivation for these deployments has been to improve liquidity, which some cite as a barrier to entry generally, and #3 (pact) would be a good example. If the volume and size of gAlgo / Algo swaps stays constant, the impact of our investment will simply be to a) make it cheaper swap (good thing) and b) dilute trading fees for non-foundation liquidity providers (not so good thing, and fair point to highlight).

The aim however is that bigger mass, and better liquidity that permits larger trades at lower cost, will bring more activity and volume to counterbalance dilution you identify.

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sorry but do we really need people do be able to 4x leverage governance rewards given out by the foundation? is that the defi we want to focus on? i hope not

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But it will always depeg so the price matches the governance APR. If the price is higher than the APR you can sell gALGO and instantly commit it, and get more in return. If you supply more liquidity you do not make swaps cheaper, you just give the people who do this loop more money, since they can do bigger loops more often. The same thing goes for you supplying the 30MM algo to folks finance, it all has already been borrowed and commited to governance, as long as there is a difference between borrow costs and governance rewards someone will do it instantly.

This results is that any algos commited to this liquidity incentive is going straight into governance commitments. Folks finance borrow APR is at 122% right now, your plan to reduce this did nothing. And since the governance rewards is a fix amount you’re just moving governance rewards to the foundation itself, since the foundation is collecting APR which will almost exclusively come from liquid governance participants, who can’t exit their positions since you’re not allowed to burn gALGO to repay their loan until the period ends, in 3 months.

Had you brought this up to the community instead of doing backroom deals these issues could have been brought up, it is very easy to see that the borrow APR will always approach the governance APR since it’s literally free money for someone planning to commit for the entire period. Supplying algos like this only boosts Folks Finance TVL and rewards, while reducing the defi rewards for every other protocol that doesn’t receive incentives.

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I am also going to share part of the discussion on discord here, since this is a more permanent place for discussion.

Swaggelwander | Vestige.fi — Yesterday at 10:50 PM

Am I reading this right (Daniel Oon | eaudoon.algo (@EauDoon): "@FolksFinance Lending, consistently has users borrowing from the ALGO Lending pool over the past 15+ days. We observed ALGO APY lending rate spike to over 10% APY. AF stepped in to provide more ALGO into Folks Lending on three occasions, 10m ALGOs per tranche totaling 30m ALGOs." | nitter); they are supplying 30mA to folks which is worth 6m$, and folks in total has 9.3m+500k+200k+150k TVL in their lending platform? This means that the foundation is propping up about 60% of folks TVL (outside liquid governance)?
60% of a protocols TVL coming from the foundation seems very unhealthy

Swaggelwander | Vestige.fi — Yesterday at 10:58 PM

And at the same time Adri is telling me that they don’t want to incentivize governance-only apps, see ⁠🏛│governance⁠, and this liquidity is only being used for selling galgo into algo to gain more governance rewards, and to be able to “4x leverage their commits”. It does not feel like a level playing field. It does not feel very healthy at all. (edited)
But folks currently has 40m$ in liquid governance, and without the foundation help only 3m$ in their regular lending market. To me that seems like a governance only app.

Adri — Today at 9:15 AM

I said that “I, Adri, find it a slippery slope for anyone to design their products based on governance rewards”. My opinion does not prevent projects from doing what they choose to (this is web3 after all) and I added your ARC suggestion to our team’s to-do list to document the requirements as you requested. I understand that you are frustrated, but these two things are unrelated IMO.

Swaggelwander | Vestige.fi — Today at 9:36 AM

But it’s not web3, I can’t just decide that you will include the product I am building in liquid governance, I can’t decide that my LP tokens or my farm will be permissable, there is a governance committee that does that you’re head of. So when you say that it’s a slipperly slope that signals to builders that your product might not be deemed worthy, since this isn’t controlled by smartcontract and rather by a centralized group of people who have opinions. And then another part of the foundation is throwing money towards project who are just existing because of playing governance rewards.

As a builder this is really frightening, I am investing time, money and a lot of effort into building cool DeFi things on this chain, but there is this huge looming hand of “I hope that the foundation will understand what I’m doing so that I too get liquidity, governance inclusion, etc”. This is not fun, and this is a huge stress.There is a risk that outside people who are thinking about building things on this chain sees the centralized actions and backroom deals like this and go somewhere else, because building into an environment where a few people decide your fate is an enormous risk.

Especially when Benedetto from Folks is suddenly speaking on the behalf of the foundation, saying that they went through a months-long process (behind closed doors) to get to here. Do I have to play politician just to have a chance of maybe getting a 150% TVL boost from the foundation? Folks Finance is a decentralized protocol, if AF wants to add liquidity they should just do it, it shouldn’t be up to Benedetto to lobby for it. At the end of the day TVL is a huge metric in web3, having a foundation act like a central bank which provides liquidity to people they like is awful.

And as a sidenote, algofi has a 58.5% borrow APR for algo as we speak, why is AF not depositing ALGO towards that right now? It’s decentralized so it can be done without any backroom deals, you just do it.

The optics of this is awful in every sense of web3. AF is positioning itself as a central bank that provides liquidity to protocols it deems worthy, which is a huge risk for builders. Just imagine the headline “Algorand Foundation supplies 60% of TVL to their second largest lending platform to lower insane borrow fees”. This is the opposite of decentralized, it is the opposite of web3. This will be my last post on the matter, but I really hope you guys listen. I am a very active builder having multiple dApps on chain, and I am currently building a lot more. I have 1000 messages in this discord, and it feels like my voice is not being heard at all.

Oh and I forgot to link to where Benedetto spoke, just to remove any ambiguity here it is: Benedetto (@BenedettoBio): "We went trough a long process (months) before we had approved the liquidity provision. The AF is open to provide liquidity and support to everyone as soon as you demonstrate reasons and value. The same goes not only for liquidity provisions but all their types of support. In the end, supporting gALGO cannot be compared to any other projects in the ecosystem. As gALGO has been designed with the purpose of increasing utility of governance for everyone. PS. Folks distributes the governance revenue with all the partners. I am not aware if other projects do something similar so far." | nitter (edited)

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i want to also add two points (from the discussion in discord):

if the foundation wanted to help out FF because of high borrow APR why do it before the sign up ended? all you did was enabling people to degen more into 4x leverage governance and the foundations ALGOs being now stuck. algorand defi should not be focussed on enabling this kind of stuff and the foundation coming in only for this looks bad imo.

additionally, you set up a dangerous precedent. can i now expect the foundation to help out lending platforms if the borrow APR is too high? You did it once, so i can surely bet on you doing it again. or will you only do it for lending platform that have good connections to the foundation? these are all questions that wouldnt be there if there would be a vote about the >30M ALGO you just deployed and you cant easily extract again. the community has absolutely no idea what happened between you and FF and that is scary from my point of view, what are the reasons and values on why this would be a good use of ALGOs from the foundation?

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By influencing the supply side of the liquid governance program, the foundation has in effect become the counter party for all the leveraged commits. Since we can assume it will likely reach an equilibrium (probably one where most leveraged commits won’t make a return, or at the very least close to no return, depending on where the equilibrium lands) what you have instead is the foundation essentially making APR off of the borrow, which in turn comes from governance. Thus creating a bizarre loop where the foundation in essence has indirectly paid itself.

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People were doing much higher than 4x leverage on AlgoFi before Folks even existed. This seems like a straw man argument. There are funds set aside in Foundation wallet for exactly this sort of thing. Whether it was appropriate or not in this instance, I would say yes. Liquidity for supply and demand when there is a huge demand seems important to the ecosystem. I’m sure if AlgoFi didn’t control their smart contracts maybe they would have been helped out too.

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thats not my point, its not about algofi vs folks its about the foundation now actively supporting this behavior (and the math says you cant do 4x on algofi just so you know, the ALGO efficiency + higher cf of gALGO on FF enables this). if the foundation would have deployed liquidity on algofi to enable this i would be still against it, i dont care about a specific protocol when it comes to this kind of stuff. just stop treating protocols differently, especially when the discussion on why to do this happened behind closed doors.

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Communication in general seems to be the issue. I only just learned that this was even an option the whole time after asking around. If it didn’t need to be put to a vote, and it is helping the ecosystem, there were funds set aside for such a thing, and there won’t be losses associated with it…other than the fact that gALGO LP APR won’t be as high, I don’t really see the issue.

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The issue is that the foundation is supplying 30MM algo that are borrowed and recommited to governance. When someone borrows these algos they pay an APR. This APR goes straight to the foundation, and this APR is taken from the governance rewards. The foundation is literally funneling governance rewards back to themselves, which decreases all other governance rewards, both the defi incentives along with regular governance by dilluting the share. This is not organic defi activity, it’s a central bank creating synthetic supply.

And yes, the lack of transparency is a huge issue. This should have been put to a governance vote, or at the very least been publicly discussed. This is a tradfi solution to a non-existing problem.

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I agree this seems like something that should have been put to a vote, but I think the fact that there was a limited supply of ALGO available in the wallet where this liquidity came from would presuppose a limit to the power on-display here. That said, even if we had the mechanism to make such an emergency vote (hopefully xGov will help here in the future), and the Foundation agreed that the funds in this liquidity provision wallet were under community control, I think people would still be upset. I really think we’re “looking a gift-horse in the mouth” as the saying goes.

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yes they would be, but they would have to accept what the majority of community wants. thats how decentralization works

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It’s not really a gift though, it’s at worse going to encourage heavier risk taking that will incur in user loss (you can argue that they should’ve read the fine print, which is fair enough imo), and at best going to funnel the rewards they themselves pay, in the form of APR. So the equilibrium point at which we reach is one where every algo in governance gets less rewards, since more algos that weren’t originally going to participate took part in governance, and the foundation, indirectly received either the yield from those algos or more than the yield of those algos, depending on the final equilibrium reached.

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The foundation excluded Algofi, Tinyman and Humble out of regularity issues probably. They are not as decentralized as Pact or Folks. Same thing about selecting gAlgo/Algo pool over others. (Thanks to Choppa&Averagezen for clarifying this in my head)

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who says that? which metrics are you using?

tinyman and humble are also not US companies, so whats the problem?

actually the important point: why are we discussing which protocol is the most decentralized? we shouldnt fight over protocols. and why do we need to think about why they did something? they could tell us, the community is here why are they not talking to us beforehand?