Exploring Moats surrounding Alchemix Finance
Overview
Alchemix Finance unlocks future yield for users assets by issuing a synthetic debt (alUSD) backed by collateral deposited into the protocol. Debt is automatically repaid by yield earned through lending collateral assets. To maintain stability of alUSD, the token acts as a fungible claim on the underlying collateral. The project is governed through a DAO, using the ALCX token. There are many instances of established DeFi projects being forked. The discussion below explores the possibility of ALCX contracts being copied and redeployed through analysis of Alchemix’s moats. The moats examined are liquidity, community and tokenomics.
Liquidity
Fungible redemption of the underlying collateral incentivises the provision of liquidity to alUSD. If the market price for alUSD is below peg, debtors are incentivised to buy alUSD to pay down their debt at a discount, and arbitrageurs are incentivised to buy to profit from redeeming the underlying collateral. In the event alUSD is above peg, users are incentivised to mint alUSD with collateral and profit from the difference between. Such a system is designed to guide the synthetic debt towards a stable price using economic incentives, regardless of the liquidity or network effect of the implementation. In theory, this mechanism design allows for a fork of Alchemix contracts that could maintain the peg of alUSD with little initial liquidity, thereby fragmenting the value capture of the Alchemix protocol. On closer examination, it appears liquidity is the key moat around the protocol. A large user who wants to unlock yield on a whale size position could cause slippage when selling alUSD, thereby encouraging use of the most liquid instance. Therefore, the optimum user experience is centred around maximising utility through enabling the disposal of unlocked yield with the least slippage. The aphorism ‘liquidity begets liquidity’ applies to this scenario. The greatest liquidity attracts the most users, thereby increasing the liquidity further. Thus, this is the most important moat for Alchemix, and it should be closely defended. The biggest threat to Alchemix is that a platform with existing liquidity implements a fork of the Alchemix contract to add to their existing suite of financial primitives, bootstrapping liquidity from their existing user base. Alchemix has successfully bootstrapped liquidity to the platform through their yield farming initiative. The liquidity moat should be fiercely defended by continually incentivising deep liquidity for alUSD/collateral pairs. Furthermore, it should be an imperative to seek “mergers” with larger ecosystems, through partnerships and integrations in order to reduce the risk of established DeFi protocols attacking Alchemix liquidity.
Community
The token distribution of ALCX further cements the protocol’s defensibility through its fairness and incentives creating a strong community. With 60% of the supply of ALCX designated for liquidity mining rewards, users are the largest benefactors of the token supply. The DAO holds 15% of the supply for discretionary allocation by ALCX holders, plus a further 5% earmarked for bug bounties. A whitelisted pool holds the remaining 20% of tokens to be mined by the development team, encouraging skin in the game for existing team members, plus a bounty incentive for new developers to contribute. Furthermore, genesis of the project was publicly announced, no privilege was given to insiders before the token launch. The token distribution has enabled strong alignment between community and developer team- a strong foundation for a resilient community. The community would not benefit materially from a protocol fork to change the parameters of the token distribution, as there is no misalignment between token holders. Thus, there is a low probability that a community fork would gain traction. Community alignment is a strong moat for Alchemix.
Tokenomics
Token emissions through yield farming are an effective mechanism for generating desired user activity on the platform. Modelling the emission schedule in line with the structure of inflation on the well-established Synthetix protocol is a safe bet between incentivising long term bootstrapping of user activity without the trade-off of diluting the token supply to an extent that would harm the token value. Whilst a 3 year emissions schedule with gradually reducing tail-end inflation does not compete with ‘degen’ level yields offered by other nascent projects, it is sufficient to incentivise immediate engagement. Sustained long term reward schedule disincentives fickle liquidity that chases short term yield, solidifying a user base of long-haul stakeholders. ALCX tokenomics proves to be a strong moat against a fork offering higher emissions.
Conclusion
Through careful design, Alchemix Finance has launched a protocol that is showing early signs of forming strong moats. Liquidity is the strongest moat, and should be closely defended to ensure optimum user experience. Deep liquidity and ecosystem ties are required to defend this moat and should be a central focus. There exists a strong alignment between the users and developers of the protocol, solidifying a strong foundation for a resilient and enfranchised community moat that is unlikely to be attacked. The token model is an effective balance between bootstrapping initial liquidity and sustaining long term stakeholders.