Protocol-Owned DEX Liquidity (PODL) Contracts Explained

For the past few weeks, one common novelty amongst decentralised exchanges on a number of Ethereum competitor chains has been the introduction of the so-called PODL contracts. In this article, we will demystify the idea behind them, and explain the opportunity that they present.

Platforms Utilising PODL Contracts

Protocol-Owned DEX Liquidity (PODL) contracts should not to be confused with Tribute’s Proof of Decentralised Liquidity, abbreviated PoDL with a lowercase “o”.

This article is focused on Protocol-Owned DEX Liquidity contracts which have become increasingly popular during the past few weeks thanks to their integration into two particular platforms – Blizz and Geist. Both services are forks of Aave v2 which provide greater utility for their token holders. Both have seen immense growth since their fairly recent launch. More specifically, Blizz is the fifth largest DeFi protocol on Avalanche with more than $887,000,000 in TVL, whereas Geist is the second largest service on Fantom with $734,000,000 in TVL.

While superior profitability thanks to ecosystem rewards certainly played a major role in the major success of these platforms, one additional factor are the newly-introduced PODL contracts.

How PODL Contracts Work

While at first the four letter acronym might strike someone as yet another piece of added complexity to DeFi, the idea is quite simple – it is a smart contract which allows users of the platform to sell their liquidity provider tokens for a premium.

For the unaware, liquidity provider (LP) tokens are the tokens that users receive once they have deposited liquidity into an automated market making decentralised exchange.

In the case of Blizz, the tokens accepted by the contract are the BLZZAVAX tokens received when the user deposits liquidity into Trader Joe‘s BLZZ-AVAX pool. Once the deposit transaction is completed, the user can simply go to the PODL page on the Blizz website in order to sell his/her tokens, receiving 10% more AVAX than the tokens are worth at current market rate. That is, as long as there is any AVAX available, which is rarely the case.

Free money sounds great, but this process raises two important questions:

1. What happens to the liquidity provider tokens that the platform buys from its users?
2. Where does the “free money” come from and at whose expense is this process happening?

The first one is easier to answer – the liquidity remains forever locked in the platform, ensuring two major benefits – constantly growing reliable liquidity for the platform’s native token, and increased scarcity of the token itself (or at least a reduced circulating supply growth rate).

On the surface, the second question also has an obvious answer – the free money comes from the AVAX incentive program in the case of Blizz and the FTM incentive program in the case of Geist. The “at whose expense” part of it, however, is more complicated.

Issues with PODL Contracts

While given the total circulating supply and issuance rate of AVAX and FTM, the rewards redirected to PODL contracts are minuscule and could not crash the price of either of the two coins, one could argue that they are not necessarily being spent the way they were intended to be spent.

Both the FTM and the AVAX incentive programs were launched with the goal of attracting lenders, borrowers and liquidity providers to platforms on their respective networks (Fantom and Avalanche). With the introduction of PODL contracts, 50% of the incentives on both Blizz and Geist are given to coin flippers, instead of improving APR-s for platform users. In addition, the Blizz contracts are especially notorious for being constantly emptied by what appears to be bots that are taking advantage of the arbitrage opportunity.

With Geist, some of the issues have been circumvented by the addition of cleverly picked requirements – namely the need to have GEIST staked in order to take advantage of the preferential rate.

While this solution does help with the arbitrage bot problem, it is still unclear whether the FTM that is sold to liquidity providers is fulfilling its purpose of attracting users to the Fantom network. While increasing APR for lenders, for example, would result in higher usage of Fantom, using incentive program FTM to essentially purchase and burn GEIST tokens is taking value away from FTM itself, in order to increase the value of GEIST. The same is valid for the BLZZ token, too.

That being said, this is a problem for the Fantom Foundation and the Avalanche Foundation. The presence of this contract does not directly hurt the users of the platform (apart from redirecting coins that would have otherwise been given to lenders and borrowers). So while neither of the institutions is raising the alarm, all that is left for users is to consider these contracts a potential part of their portfolio management strategies, and if deemed sensible – to take advantage of the given opportunity.

With Blizz, this is a difficult task, since the Protocol Owned DEX Liquidity Module is constantly emptied. Most of the time this is true for GEIST as well, but the increased participation requirements do alleviate this problem to an extent. Unfortunately, this does happen at the expense of introducing an opportunity cost (the need to purchase and lock GEIST tokens).