A glimmer of hope

published on 03 April 2022

Hello dear CT, you have read the title well, we are feeling bullish these days on DeFi, let’s dive in.

As usual, before we proceed: This article is not meant to be financial advice, I strongly suggest you do your own research and take decisions solely based on what you have found…

1. Did someone say APY and not inflation? 

It is now a well-known fact (well at least I hope it is) that what is used as a reference for a given %APY in DeFi is in fact mainly inflation. Ok, yes, there are some protocols that do not sell inflation but provide more advanced yield returns like AMM and lending products. Yet they are a minority by design and do not offer such an attractive yield for the average user. 

I’ll give you a bit of “DeFi History” to set the context… It’s summer 2020 and you’re stuck in front of your computer aping in whatever project there is to “profit” from insane APY and excuse my French : eat like a horse. Maybe because everyone was so euphoric, maybe because we’re all dumb or maybe because we chose to look away but it took us some time to realize that: no, there is no magic Yield coming out of blockchain. We would pass the future inflation to the next stupid user who would also try to pass the buck to the next user and so on...

As time pass, people eventually realized that (and instead of  building novel primitive that could provide true and sustainable APY) decided to go full PVP, creating the well known term “Mercenary Capital”: investing large amount of money and then migrating from one farm to another as soon as the APY become less attractive, dumping yields on other while doing so.

But since there is no DeFi without liquidity provided by users, in the span of two years heavily inflated tokens have become common, for lack of any better solution. To the infamous question “Where does Yield come from in DeFi? ” you could answer “inflationary mechanisms” and be right 99% of the time. I hope a discerning eye will have noticed that I said 99% and not 100%, which means that... there would still be hope?

2. Blockspace as a commodity

You’ve probably proofread this title several times (or maybe not), and asked yourself: what the fuck is he talking about? Let me explain:

Again, you probably know this already but, each time you’re sending a transaction through the blockchain, the fee attached to your transaction is, among other things, to send a signal that you want to buy “blockspace”.

Blockspace where your tx resides is capped by a limited number of transactions that can go through at a given time. It implies that Blockspace has an economic value that can be extracted in one way or another (MEV,…).

In an (rough) attempt to make the subject easier to understand, I won't go into too much detail. If you want to learn more on the subject, have a read at those articles.

With the unique architecture of Ethereum, miners who secure the network by mining blocks receive different incentives from block reward to gas fees and MEV. As time passes and with MEV getting a lot of traction, Mining has become a very lucrative business.  Since EIP1559 volatility of gas price have smothered a bit allowing for a fairer price for the end users but it remains costly.

Since Blockspace can be considered as a commodity, how miners & users could get benefits from it ?

3. Who gets what and why?

Let’s first take a look from the supply side. Assuming I’m a miner, why would I want to sell a portion of my hashpower? My sole revenue comes from mining, earning gas fee and potentially MEV, those earnings have something in common: they’re all denominated in the basis currency that is being used by the blockchain e.g. ETH.

When it comes to hedge myself (as a miner) against potential market decline, I have only two choices: either bear downward price action & sell my rewards or hedge myself through derivatives and options. But I am constrained in my choices because none of these instruments can perfectly hedge my income (unpredictable by nature) over time

Currently, the best way to hedge yourself as a miner would be to buy/sell your mining machines, no need to explain how inefficient this type of niche market can be (import/export machine, real world constraint…).

Don't be scared if you don't get the full grasp of it, the demand side is easier to understand.

As an end user of blockchain, how could I benefit from buying hashpower, hence acquiring a share of every Blockspace produced on a given period. It could be an effective way to hedge myself against gas fees: let’s say as an Exchange you could buy hashpower to mitigate the fees spent in withdrawals. Even as a user, you could speculate on or hedge yourself against gas fee price and make a decent return on it. What if I tell you there is actually a way of doing so? Read on anon, read on...

4. Introducing Alkimiya Protocol - Hashpower structured product

The whole paragraph above boils down to this: the widespread tokenization of hashpower, which is essentially a liquidity flow.. So how are they making it possible?

Think of it as a similar product to Yield-token (YT-OT) assets like Pendle finance, Element or APWINE. If you’re not familiar with these concepts & protocols, you’ve probably been lazy on your homework anon, but it’s ok i’ll give you a catch-up.

The basic core of the Alkimiya Hashpower product is based on two components :  Silica contract and Hash vault (Yield vault). Let’s start with the Silica contract:

Silica contract represents a commodity swap between buyer and seller of hashpower.

The seller of the Silica contract will set up an extra hashpower that he’s ready to sell to the buyer under a vesting-dripping contract. The buyer provides a fixed quantity of coins/token requested by the seller and which will be distributed by the contract every day as an incentive for the seller to constantly provide hashpower until the end of the contract.

For a more practical example, here is the definition of the ETH swap contract:

Swap contract between ETH mining rewards and an upfront payment. Seller creates a contract that forwards all mining rewards from mining X Gh/s over the course of Y days in exchange for a fixed payment from the buyers.

If the seller sees greater demand for hashpower, he can then charge a high premium to the buyer. On the contrary,  if the seller mispriced the ETH swap contract, the buyer is incentivized to take advantage of the contract (arbitrage/analysis). Although risk is mitigated by the ``vesting” contract, the seller of hashpower can decide arbitrarily to stop supplying hashpower (and thus the rewards) through the contract. That is why the seller must deposit an initial amount of incentives that covers more than one reward day. In case of non-agreement between the buyer and the seller, not only will the rewards and coins acquired be returned to the seller and the buyer, but also because of the discount mechanism, the seller will be "punished" in case of default, which is what Alkimiya refers to as "liquidation".

"Hash vault is very similar to the silica contract, except that it is an aggregate of several silica contracts. Let's say you have a bunch of silica contracts, one could build a fixed bond income and enjoy a much more sustainable return. Since silica contracts effectively issue tokens that will be burned in the event of a default or settlement of the contract, this opens up many possibilities. One could recreate Options based on Silica Hashvault or the Silica contract. (I actually see it as Options payoff already, but I think there is more to explore).

5. Conclusion, congratulations if you made it this far

At the risk of repeating myself, I want to state it again: "A glimmer of hope". It seems that we are not that far away from producing a genuine return that is not driven by high token inflation. By taking advantage of Hashpower, you are actively earning rewards from the blockchain economy. That really does sound less scammy and ponzified than vote-escrowing your tokens, doesn't it?

With its well-designed contracts, Alkimiya offers more than just participation in a blockchain economy, but also gives the freedom to replicate/build products on top of the Silica contract. We've already talked about the repayment of a fixed bond, but one could create Options, Perpetual Swaps and so on...

The title of this article goes beyond the topic, I have found many projects in recent months that are finally extracting value from the blockchain economy rather than from the users pocket. I still think we're a long way from mass adoption and the blockchain that will onboard the average Joe isn't born yet, but a lot of new primitives will pop up in the coming months.(and probably way more than you expect)

Anon, you do want to chase every protocol that uses its own blockchain as an architecture instead of just being a mere rip-off of Ethereum, that's where Alpha is.

Footnote: It's been a while since I wrote an article with the intention of publishing it. I always end up not publishing my article because I think I lack knowledge and so my Substack/Medium are overrun with drafts. However, it feels good to write to you again anon. Take some time (5-10mins) to reflect on what you have read, it goes a long way to form a critical thinking. “Esprit critique” will always make a difference…

Special thanks to @0x_groova who guided me on the path to better English writing .

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