Analysis | Sushi reduces production and locks up positions, can mining profits continue?

The popular DeFi project Sushi completed its migration at around 10 o'clock last night, and the Uniswap market-making LP funds pledged by users on Sushi were migrated to SushiSwap. For Uniswap, it was like being fleeced - the amount of locked funds decreased by 66%, which is equivalent to a loss of more than 1.1 billion US dollars.

SBF himself live-tweeted during the migration process

On the non-small DeFi data page, we can see that SushiSwap's locked-in volume has surpassed Uniswap and even MkaerDAO, ranking second.

New proposal to reduce production and increase lock-up period

In addition to the increase in coin prices brought about by the smooth migration, there is also a new proposal from the SuShi community that deserves attention: changing from 100 Sushi rewards per block to 50 SUSHI per block in the first and second years; 25 SUSHI per block in the third and fourth years; and 10 SUSHI per block in the fifth year.

In addition, 2/3 of the newly issued SUSHI will be locked for one year. The locked SUSHI can still earn fees, but cannot be sold or used for voting before being unlocked.

According to the proposed model, there will be 600 million tokens by the fifth year, instead of the 1.5 billion currently planned.

That is to say, the additional issuance in five years will be cut by more than half, and the selling pressure will be reduced a lot, which is indeed very beneficial to current Sushi holders. The proposal will end at 8 o'clock tonight. At present, the supporters account for 89.4% of the votes, and the proposal to reduce production is basically a foregone conclusion.

This issue of Feixiaohao Research will analyze the benefits and costs of Sushi liquidity mining from a rigorous data analysis perspective, aiming to help everyone judge whether Sushi is worth long-term investment and what hidden risks the project may have.

Liquidity Mining Process on SushiSwap

To help everyone better understand the so-called "liquidity mining", we drew a flowchart of the participation steps.

The above is an example of the mining process of the ETH/Sushi pool. The Sushi reward of this pool is the best among many Sushi pools that support mining. In simple terms, liquidity mining requires you to deposit the tokens and Sushi of the pool in a 1:1 ratio. After inputting liquidity into the pool, LP certificates will be generated, and Sushi tokens will be rewarded to you.

Deposit coins into the pool (provide liquidity) - reward you for depositing coins and give you coins (liquidity mining) - withdraw coins (end mining, take away the principal and income)

Cost structure of mining

From the above mining process, we can see that mining is not for free. Your deposits and withdrawals are all on-chain transfers, so the cost incurred is multiple ETH transaction fees.

The composition of a single transaction fee consists of two parts: the amount of Gas and the Gas price. These two factors are variables, and the specific relationship is as follows: Operation fee = Gas amount * Gas ​​price. For the convenience of calculation, we took the average of the last 10 single transaction fees, which is approximately 0.007273457 eth.

Note that the amount and price of Gas are affected by whether the transaction is possible (how large the transaction volume is at the time). This is also what we often say when transactions are congested, the transaction cost is higher.

Mining income structure

Currently, the income from liquidity mining consists of the following two parts: rewards for each block (100 Sushi, which may be reduced to 50 if new proposals are passed in the future) and 0.3% transaction fee rewards in SushiSwap (0.25% paid to active liquidity providers and 0.05% paid to Sushi token holders).

Blockchain Rewards

Each block is rewarded with 100 Sushi tokens. Blockchain rewards are affected by the following factors:

• 1. The time it takes to generate a block. Assuming other conditions remain unchanged, the shorter the time it takes to generate a block, the more value it generates per unit time.

• 2. The number of Sushi tokens rewarded by each blockchain is decreasing. The number of Sushi tokens generated by each block is decreasing, and this part of the income will also decrease;

• 3. Sushi token value. When the value of Sushi token increases, the income increases;

Fee Rewards

Participants who provide liquidity will receive a 0.25% fee reward, and 0.05% of the fee will be rewarded to Sushi token holders. The amount of the reward is affected by the following factors:

• 1. The length of holding period. Returns are calculated based on time. The longer the holding period, the higher the return.

• 2. The proportion of liquidity provided in the liquidity pool will gradually increase, and the proportion of rewards obtained in the entire liquidity pool will gradually increase;

• 3. Fee level (including single fee*number of transactions);

• 4. Sushi token value. When the value of Sushi token increases, the income increases;

Factors affecting risk and return after extraction

Formula extraction (Formula 1-Formula 6)

Net income = income - cost [Formula 1]

Revenue = Block Reward + Liquidity Pool Transaction Fee Reward + Sushi Holder Transaction Fee Reward [Formula 2]

Substituting [Formula 2] into [Formula 1], we can get [Formula 3]

Net income = block reward + liquidity pool transaction fee reward + Sushi holder transaction fee reward - cost [Formula 3]

Splitting [Formula 3] gives [Formula 4]

Net income of a user = (average number of block reward coins per day * proportion in the fund pool + 0.25% daily transaction fee * proportion in the fund pool + 0.05% daily transaction fee * proportion of SUSHI tokens held) * number of investment days * Sushi coin price fluctuation - Ethereum transfer fee [Formula 4]

The above formula seems to be complicated and difficult to grasp the rules. We need to simplify [Formula 4] and the simplified calculation process is as follows:

First, transform [Formula 4] into a user's net income = (average number of block reward coins per day + 0.25% daily transaction fee) * proportion in the fund pool + 0.05% daily transaction fee * proportion of Sushi tokens held) * number of investment days * Sushi coin price fluctuation - Ethereum transfer fee

【Assumptions】

- 1. Assume that the proportion in the fund pool is approximately equal to the proportion of Sushi tokens held;

- 2. Assume that Ethereum transfer fees are relatively stable over a certain period of time

The simplified formula can be obtained:

Net income of a user = (average number of block reward coins per day + 0.3% transaction fee per day) * percentage * number of investment days * Sushi coin price fluctuation - similar constant transfer fee

Since the average daily block reward coins and daily handling fees are directly affected by the transaction volume, and the Ethereum transfer fee can be regarded as a constant, the profit formula is finally simplified to [Formula 5], as shown below:

[Formula 5] Profit = f (transaction volume, proportion, time, currency price fluctuation)

Since the proportion is insensitive to the rate of return, the formula 6 is as follows:

[Formula 6] Rate of return = f (transaction volume, time, currency price fluctuation)

Relevance of the main elements

From the above [Formula 6], we can know that:

• 1. The larger the transaction volume, the higher the rate of return;

• 2. The longer the holding period, the higher the yield;

• 3. The higher the coin price, the higher the yield.

Of the three factors mentioned above, miners can only control the second factor, i.e. the holding period; while both trading volume and coin price are reflected in the market’s recognition of Sushi. The more recognized Sushi is, the higher the trading volume and coin price will continue to rise.

Next, we will focus on analyzing how the core factor [coin price] is affected by supply and demand.

Sushi is hurt by a sharp increase in supply

As mentioned above, the price of the currency is affected by supply and demand. Although the supply of Sushi tokens is unlimited, at a certain point in time, the supply of tokens in circulation is fixed (the proportion of newly added circulation is small). Therefore, we can get the supply and demand curve of Sushi tokens as shown in the following figure:

The above figure is a supply and demand analysis commonly used in microeconomics. The horizontal axis is quantity represented by Q, the vertical axis is price represented by P, S0 represents the supply curve, M0 represents the demand curve, and point A is the equilibrium point when the supply and demand of Sushi coins are balanced.

Although the total amount is unlimited, we believe that the short-term continuous supply is certain, so the vertical line S0 in the figure represents the supply

As the quantity continues to increase, the price of the currency will decrease when the demand is constant, so the slope of the demand curve is negative.

Previously, Chef Nomi, the former founder of Sushi, sold 18,000 ETH to cash out, causing the price of the coin to drop to as low as $1.138, which is almost 90% lower than Sushi's highest price.

This behavior is to increase the supply of Sushi, and the supply curve will shift to the right, as shown in the following figure:

At this time, the new supply curve is S1. At this time, when the demand remains unchanged, the Sushi coins circulating in the market increase from q0 to q1, the price changes from p0 to p1, and the new equilibrium point changes from A to B.

18,000 ETH can move the supply curve and cause Sushi to fall by 90%. This also indirectly shows that the liquidity mining pool is not very large, and the depth provided by retail traders is not great. It seems that Sushi, which is once in the limelight, is not as prosperous as we think.

In fact, in a normal, healthy market with strong demand, the impact of 18,000 ETH should be as follows:

The figure shows that as demand increases, supply is appropriately increased, and supply and demand reach equilibrium at point C. After equilibrium, the number of Sushi coins in the market changes from q0 to q1, expanding the scope of token use. However, the price p1 after equilibrium is roughly the same as p0, ensuring the stability of the coin price.

It is obvious that the founder was too anxious to cash out. The selling created too much new supply, while the actual demand was not as strong as hyped. In short, this cash out that broke the balance of supply and demand was a very failed cash out for the Sushi project.

However, since Sushi was taken over by FTX founder SBF, the community has been keen to vote on various distribution strategies to reduce inflation. Whether it can really stabilize the supply and demand of Sushi, or rely on deflationary benefits to push up the price of the currency and then cash out at a high level, it is impossible to draw a conclusion now, but everyone needs to be vigilant.

Evaluation of Sushi Liquidity Mining as an Investment Option

If Sushi mining is regarded as an investment project, let us describe what kind of investment it is.

- 1. Sushi mining is a long-term investment product. Since you pay a cost every time you enter and exit the market, the profit is calculated based on the holding period. The longer you hold, the higher the profit will be, and the more it can cover the cost and obtain net profit.

- 2. Considering the handling fee issue, most of the income is transferred to the wallet together with the withdrawal of the liquidity mining principal, so liquidity mining is a simple interest model. It cannot generate new compound interest income with yesterday's income after the daily settlement like futures or spot trading.

- 3. Unlimited issuance and crazy cashing out by early founders make it hard to see the intention to do Sushi well. (The deflation strategy promoted later is more like the behavior of big players and vested interests). In addition, it is not to mention that malicious drainage before Uniswap is an unfair competition behavior, which is not conducive to the healthy development of the currency circle and also affects the image of DeFi in the minds of retail investors.

Benefit and risk estimation

The following figure is a list of expenses we quoted from a user on the Internet for his Sushi mining income.

As can be seen from the above figure, it is generally necessary to hold Sushi for more than 1 day to obtain a positive net return, but who can guarantee that the price of Sushi will not plummet within this day? Now, if a DeFi mining project survives for more than 3 days, it will be jokingly called an "old project" by people in the industry.

In addition, the block reward of Sushi after migration has been reduced from 1,000 to 100, or even 50 or 25. Once the high mining rewards are lost, will liquidity providers still be willing to continue to stake Sushi? If new and better mining projects emerge, there is no doubt that being replaced may be the inevitable fate of Sushi. For example, Uniswap, which has been ruthlessly "snatched" by Sushi, may issue its own platform currency in the future...

In addition, all liquidity mining involves factors such as the risk of uncompensated losses, and investing in similar projects is like trying to grab chestnuts from the fire.

【Tips on Impermanent Loss Risk】: Uniswap, which uses the AMM (Automatic Market Maker) mechanism, presents prices according to the exchange rate changes in each trading pair pool. For liquidity providers, if the exchange rate of two assets in the liquidity pool changes significantly, losses will occur. Providing liquidity for currencies with greater price fluctuations, the risk of impermanent loss is higher, which has led many users to find that the income from mining is not enough to cover the losses from impermanent loss.

The above is our analysis of Sushi liquidity mining. We know that the main factors affecting the rate of return are trading volume, holding period and token price fluctuations. You can also use similar ideas to evaluate the risks and benefits of liquidity mining of other Defi currencies. We also hope that investors can find high-quality currencies that suit them through the data or analysis ideas provided by Feixiaohao.