DeFi: ProtoFi Protocol — Is it just a fad?
Disclaimer: Protocol is still very experimental. Anything mentioned is only my personal interpretation and how it possibly makes game theory sense. Not financial advice.
Recently, ProtoFi Protocol was getting a lot of mentions by high-profile CT influencers. A highly probable reason is their meteoric rise in TVL since its launch on 19 Jan 2022.
Within four weeks of launch, its TVL grew to $280m. Also, according to Defilamma, they briefly overtook SpiritSwap in TVL ranking to claim the top 10 positions.
Indeed, they do have an innovative token design, but does it work? Below I attempt to dissect my understanding of the protocol’s unique features, the desired outcome of each feature and how reality may differ from desired. ProtoFi has four unique token design features.
First, ProtoFi uses a dual token system. There is a native token, $PROTO, to serve as rewards and a governance token, $ELCT, to represent a share in ProtoFi. Ideally, this separates the effects of the farm and dump token, $PROTO, from the hodling token, $ELCT. Also, unlike any other dual token ecosystem, $ELCT can’t be bought or sold directly and the only way to obtain $ELCT is to stake $PROTO in LPs.
This creates a funnel-like scenario to force users, seeking to hodl $ELCT, to stake PROTO/FTM or PROTO/USDC on Nucleus. Ideally, it creates a flywheel effect that improves the condition to buy/hold $PROTO and stake more $PROTO on Nucleus, to earn more $ELCT.
However, as there is no independent market for $ELCT, the price of $ELCT is still tied to $PROTO. Hence, $ELCT holders are still subjected to the price impact of dumping $PROTO, which kind of defeats the purpose of a dual token system.
Second, ProtoFi employs an elastic supply system, named Quantum Supply, to adjust the $PROTO emissions rate in accordance with the ratio between the Market Cap (MC) and the Total Value Locked (TVL) in the protocol. To further its efficacy, the team added a barometer with clear visuals of the current and target ratio (dynamic) on the homepage to influence users’ behavior.
Ideally, this feature helps to regulate the valuation of the protocol to remain as close to fair value as possible.
However, using MC/TVL ratio as the driving force for incentivizing users can be problematic. It creates a pro-cyclical effect on the price of PROTO/ELCT, where the price action is amplified in both directions.
In a bullish macro-environment, Quantum Supply creates a double flywheel effect to drive the price of PROTO/ELCT up.
But in a bearish macro-environment, it creates a double flywheel effect to drive the price of PROTO/ELCT down.
Third, ProtoFi has an anti-whale transaction monitoring system, named ProtoShield, designed to track and limit dumping at 5% of the circulating PROTO supply per transaction.
Ideally, this helps to reduce volatility in price action. But with reduced TVL because of Quantum Supply during a bearish market, the positive effects of ProtoShield are insignificant.
Fourth, ProtoFi has a rewards lock-up with a decaying penalty mechanism, named ChronoLock, designed to prevent arbitrage by bots and users seeking to exploit high APRs by harvesting and dumping PROTO frequently.
Ideally, this reduces the negative impact on the value. But, again, with reduced TVL because of Quantum Supply during a bearish market, the positive effects of ChronoLock are insignificant.
At this point, PROTO/ELCT feels more like a leverage yield farming play giving users amplified exposure to market directionality. In an idealistic up-only scenario, the ponzinomics behind ProtoFi is probably great for positive price action. On the flip side, the ponzinomics amplifies the downward price action too, which can be disastrous for many late entrants.
On another important note, at this point, I have questions on how they are going to compete with SpookySwap, SpiritSwap, Beethoven-X and Solidly. They may only be able to compete in bullish markets but would suffer more than the others during a bear market.
Despite their outlook, given their strong ability to ship innovative products at lightning speed, I look forward to future innovations the team has in store for us.
Bonus: An illustrative overview of the token ecosystem, with a focus on how users can participate in the pools to earn $PROTO and $ELCT.
And for further details on ProtoFi protocol, check out their documentation at https://protofi.gitbook.io/protofi-docs/
