C. Incentive Scheme: Passive and Active Liquidity Providers
The Kima protocol prioritizes liquidity provider transactions to secure the liquidity bounty and reduce costs for subsequent withdrawals. This makes bounties easy to win and low-risk, which we believe will encourage liquidity providers to build machines that follow liquidity levels and execute to make an optimal profit. As long as it is easy and profitable for a liquidity provider to deposit an asset and collect a bounty, and it can be done quickly, we can rely on the system incentives to guide liquidity to where it is desired, maintaining at least a level of K1 liquidity (the lower boundary of the optimial liquidity level) for all pools. The high quality of service and the low fees on well-funded pools (pools well above K1) generate an attractive business case for Liquidity Providers, who earn a portion of the costs.
Liquidity providers provide liquidity to the Kima protocol by sending Liquidity Provision transactions and depositing an amount into one of the system’s pools. Such liquidity providers can generate a return in two complementary ways:
Passive Liquidity Providers (PLPs)
A PLP sends liquidity to one of the Kima pools. This transaction might win her a bounty if sent to a pool where liquidity is needed (pool balance is below K1). From that point, until the PLP decides to withdraw her liquidity, she earns a portion of the network fees collected on the entire system (0.05% of the transaction amount).
The Kima protocol is designed to achieve high capital efficiency - a high ratio of transfer volume per dollar of liquidity - which directly translates to a higher return for PLPs (more fees to the dollar). This is a passive strategy, which does not require any decision-making from the PLP and generates ongoing returns from the network fee income.
Based on our simulations, $1m of daily volume would yield $500 in network fees per day (or $182,500 per year), with half going to the PLPs ($91,250 annually). If capital efficiency is high and $100,000 of liquidity is enough to support the volume level (10:1), the yearly return for passive liquidity providers is 91.25%.
Active Liquidity Providers (ALPs)
A liquidity provider can take an active part and act as an ALP. ALPs move liquidity between pools: taking liquidity out of over-liquid pools and moving it to where it’s needed.
In order to do so, such ALP should monitor the state of the system pools, and constantly withdraw and deposit funds following the protocol's incentives. By doing so, ALPs can boost their return by collecting liquidity bounties on top of the passive strategy liquidity fees income.
The Kima protocol prioritizes ALP transactions to secure liquidity and reduce costs for subsequent withdrawals. This makes bounties easy to win and low-risk, which would encourage ALPs to build automated strategies (bots) that follow liquidity levels and execute to make an optimal profit. As long as it is easy and profitable for an ALP to deposit or withdraw an asset and collect a bounty, and if it can be done quickly, we can rely on the system’s incentives to guide liquidity to where it is desired, maintaining at least a level of K1 liquidity for each pool and grooming excessive liquidity from where it is not needed (above K2 - the upper boundary of the optimal liquidity level).
Quality of Service (QoS)
We define Quality of Service as “just enough” and “just in time” liquidity to support users’ demand, incurring minimum fees.
The QoS for users who perform transfers is derived from the pools' liquidity levels. For small transfers, if the destination pool balance is just above K1, the transaction goes through with no penalty at all, or a small penalty.
However, if the balance is close to K1, larger transactions would be asked to pay larger penalties. For very large transactions to go through, the liquidity in the pool should be well above K1. Thus, higher liquidity attracts larger transactions, generating larger fee income.