Title: Distribution of UMA rewards for uGas minting and Yam Treasury providing liquidity

Author: @Feddas

Forum discussions: https://forum.yam.finance/t/distrbution-of-uma-rewards-for-ugas-and-yam-treasury-liquidity-mining-proposal-and-liquidation-bot/1138

Basic Summary

The community has already approved using the treasury to provide liquidity to uGas: https://snapshot.page/#/yam.eth/proposal/QmWcns71u1c34b6sM6oJy8WoMLYcwz4b16bknTGvFFXH4x There are four additional decisions that need to be ratified on how best to use UMA rewards and treasury to support uGas and future synthetics.

1. UMA rewards availability for minting uGas and LPing vs only LPing

Yam team believes that rewards for Minting uGas and LPing will provide the highest liquidity for uGas and synths.

2. Since uGas synths expire every month, liquidity needs to be managed to ensure trading of multiple months contracts. How should we allocate UMA rewards for specific month contracts?

Yam Team believes that a weighted split of rewards on any particular month is not necessary. All rewards will be distributed to all Mint and LPers on any uGas contract.

3. Yam community has already voted and approved allocating ~$400k worth ETH from the treasury to support uGas by minting and LPing. Which month uGas should we allocate what portion of this liquidity to?

Yam team believes it’s best that we allocate 100% of this liquidity to the next month’s contract and roll it over on the 7th of every month. ie. on Feb 7th we will be moving Yam’s liquidity to March uGas contract. By providing all the liquidity on one month, it allows Yam to better manage risks of liquidation. If in the future the market matures, we can consider changing this.

4. Create and deploy a Yam Treasury supported uGas liquidation bot.

Yam team believes that we should deploy a liquidation bot to protect, Yam’s position but also the community’s positions.

Abstract

uGas is the first synthetic Degenerative.Finance is launching with and creating the right balance of incentives and liquidity is important to build out the synthetic ecosystem because uGas is only the first of many synthetics.

The UMA rewards are based on the total value of minted synthetics vs total value of minted uGas. UMA distributes 50,000 UMA per week across all synthetics. Yam will receive it’s portion based on that ratio. Yam will distribute the rewards as per our medium article 10% Yam Treasury 40% dApp mining (degenerative.finance which is also Yam) and 50% to end users. After discussing with the UMA team there are a few things that need to be discussed and determined. A few key points that UMA explained:

uGas’s primary use case is hedging / speculation. Need to add liquidity to at minimum a month in advance contract. Ie. Jan 1st, we should add liquidity to Feb’s contract. Jan’s gas usage is already starting to be known, so it’s ability to hedge or speculate is reduced. The more uGas that is minted, the more UMA rewards Yam receives to distribute.

Motivation

Yam’s goal is to create as large as possible uGas market by increasing minting and LP. We can do this by controlling the distribution of UMA rewards across uGas contracts. There are two variables that Yam should determine: Do we reward mint + LP or just LP Yam team recommends we mint + LP for now then we re-evaluate. Cons - Rewards based on total invested are approximately half due to the increased collateral requirement. Pros - Mint + LP creates a neutral position in uGas, so there’s no uGas price risk but there is impermanent loss risk and liquidation risk. Encourages more minted uGas thus creating a healthier market. Beginning, ending and weighting of UMA rewards for specific monthly contracts. Yam team recommends we weigh rewards 75%/25% for the next two months uGas contracts and roll those rewards forward on the 7th of every month. ie. Today is Jan 7th, rewards are moved to 75% Feb and 25% March until Feb 7th. Based on recommendations from UMA it is better to add liquidity to next month’s contract. How much of the treasury should we invest into each uGas contract to provide liquidity? Previously, we approved providing 50/50 liquidity to the future two months but because of liquidation concerns we need to re-evaluate. Yam team recommends that the treasury deploys 100% of liquidity on Feb contract and rolls the liquidity March contract on Feb 7th + 2.5 days governance. There is a risk of liquidation if uGas prices rise and or ETH prices fall. Since it requires 2.5 days to pass an emergency provision, risk of liquidation is possible. UMA noted that anyone can deposit additional collateral to our position at any time to reduce the risk of liquidation. If added, it can only be removed by owner of contract (Yam), so there needs to be a defined reimbursement process and or incentive program. Liquidation bots are necessary for security of the contract. Brock is currently funding and running a bot. This function should be transferred to the Yam and its treasury.

Risks

There is a chance of liquidation which we will mitigate by monitoring the position and creating a discord bot to alert everyone if there is a position that is close to liquidation. A primer on how liquidations, collateral ratios and pricing of uGas token. There are two collateralization ratios (CR): Global CR - This is the average collateralization ratio across all token sponsors of a synthetic token. When minting uGas, you must stay above this CR. Minimum CR – This is the ratio that if you drop below, your collateral could be liquidated to cover your minted assets. For uGas tokens this ratio is set at 1.25. To mint uGas tokens, you deposit ETH as collateral and it allows you to mint tokens up to the Global CR. For example if you deposit $10,000 worth of ETH and the GCR is 4, that means you can mint up to $10,000/4 = $2,500 worth of uGas tokens. In this example, if you minted 10 uGas tokens, if you return 10 uGas tokens, it will unlock all of your collateral no matter the price of the token at the time of return. Pricing of uGas tokens is derived from the 2hr Time Weighted Average Price (TWAP) of the highest liquidity AMM pool. TWAP makes it resistant against flash attacks as they only effect a single or a few blocks, then natural arbitrage should return the price back to normal. What’s the risk of liquidation? If we mint with a ratio of 3.5 and the minimum CR is 1.25. uGas 2-hour TWAP would have to increase by 156% or ETH decrease by 64% to be close to minimum CR, both of which are unlikely.