Tarot - Cycle 7
We are in support of the proposal and respect the creative attention to feedback. We’re beginning to take the view that liquidity mining and usage rewards are generally a -EV activity unless they amplify activity that is already sticky or promise to improve the function or use of protocols through composability or network effects. This proposal offers both.
It’s not clear to us that the changes made here are more cost-efficient than the original proposal made (as they’re direct incentives), but the emphasis on central tokens — wholly constructed by Tigris with little direction — speaks to the creativity and capability of this team.
Adapted from previous review
Tarot is a leveraged yield compounder. It’s a tightly scoped, essential defi lego that focuses on a few valuable features and has earned a genuine following.
On Tarot, borrowers depositing LP tokens can leverage their positions to amplify yield on their invested capital, though doing so amplifies impermanent loss and introduces liquidation risk. Liquidity providers can also deposit LP tokens without borrowing to enjoy autocompounding, similar to what Beefy offers.
On the other side, lenders can stake single tokens for variable yield, in some cases generating rates well above market with the risk of having their funds temporarily unavailable or incurring bad debt loss.
Protocols benefit from this key defi piece; Tarot encourages liquidity provision on dexes by offering LP autocompounding and juiced rewards, and we see some additional composability possible from the various borrow, lend, and collateral tokens it issues.
Optimism’s seen noteworthy organic adoption of Tarot, despite the lack of incentives to date and the limited LP coverage (only Velodrome and Zipswap). Tarot plans to expand to Beethoven X, and our expectation (and hope) is that Tarot will soon be able to cover other dexes as well.
540,000 OP over 24 weeks, or ~90,000 OP/month, for borrow and supply incentives on various Dex pairs
30% to OP-borrow incentives
This dramatically increases demand for OP and will help act as a stopgap solution until we find a more Defi-native means of deploying OP in a way that allows it to be a sustainable funding source.
30% to other Optimism pairs
All of these pairs have OP, ETH, or USDC to match the supply-side incentives.
40% to single-sided supply incentives
4500 OP/week to OP
2250 OP/week to ETH
2250 OP/week to USDC
Single-sided supply incentives
We’ll start with the single-sided lending of OP, ETH, and USDC, on which we can calculate the likely return on lending.
On Tarot right now, we’re seeing:
- OP: max of 15% APY on $400k, compared with 10% APY (incl. 6% incentivized) on Sonne
- USDC: roughly 5% APY on $1mm TVL, compared with fairly large amounts of 20% USDC from Reaper but otherwise 2-5% APY
- ETH: 6% APY on $200k TVL, compared with generally lower amounts systemwide
This tells us that additional incentives are relatively unlikely to cannibalize other protocols on OP (versus other chains), as we’re already seeing larger yields here. The difference with single-staking on Tarot vs, say, AAVE or Sonne, is that you can’t use this as collateral - this is purely providing leverage for borrowers.
This is good news for OP, as this should attract new OP acquisition for lending.
Regarding USDC, we see mostly comparable rates across high-overlap chains and an enormous amount of available liquidity already getting less yield. Same with ETH.
4500 OP/week on OP, at $0.75 OP, translates to about $176k ARR, which, on top of the roughly $56k value currently distributed annually to $400k OP, implies a rough quadrupling of lent OP to return to status quo, or $1.6mm OP, or 2.1mm OP tokens.
2250 OP/week to ETH and USDC are $88k each. ETH currently gets ~$11k returned annually, and USDC gets $45.8k returned. This implies final TVLs of $1.8mm and $2mm to ETH and USDC, respectively.
Adding this together gets you additions of $3.8mm in TVL, with a large chunk hopefully coming from outside Optimism.
The 60% to the borrow side, however, is where it gets interesting: the incentives going to this side make it much less expensive to lever up LP positions, which draws in even more LP interest and further strengthens liquidity and routing.
A look at OP/USDC illustrates this. Currently we see:
- 35% APR on $120k OP/USDC (at 1x) levered up to roughly 3x, getting ~90% leveraged APR
- $85k OP borrowed and 160k USDC borrowed
- $4mm in overall pool, $350k deposited on Tarot, $350k deposited on Beefy
Given 4x OP and 2x USDC available, utilization drops and borrow costs decrease, which in turn increases the leveraged APR from lending.
If we assume 2000 OP/week on this major pair, borrowers now get to distribute $78k rewards annually, or 65% APR on their initial capital, which almost doubles the base APR and further scales leveraged APRs (and in turn more borrowing). We don’t have enough history on Tarot performance but would love to see where this gets expected LPs on this pair. There’s enough headway here to encourage multiples, and even a 2x in OP LP would be a major improvement in lending liquidity support to Governance’s primary funding mechanism.
We expect initially a decent amount to be cannibalized from Beefy, but ultimately the rewards ought to pull more OP into LPs, and it’s worth testing this thesis considering the need for OP to provide more liquidity backstopping onchain.
Currently there is roughly $4.35mm of OP in LPs onchain, or 5.8mm OP. That is only 15% of the amount of anticipated sell pressure from the 35mm OP already live in distribution, to say nothing of the additional 12.5mm OP yet to be distributed to successful grantees.
What this means for Optimism
We see a few core benefits:
- Drawing in liquidity from other ecosystems by encouraging more productive use of USDC, ETH, and OP
- Amplifying OP rewards that have been distributed to other protocols for liquidity mining
- Providing a liquidity sink for OP
- Drawing high-use ETH and USDC to further strengthen routing liquidity
- Liquidity and activity bootstrapping aid for other protocols; subsidizes key liquidity enhancers other protocols would otherwise have to build themselves
As we said in our last review, we like proposals that immediately promise to subsidize other existing and new protocols’ activities. Tarot’s utility as a defi lego plays well into this promise.
One activity we’d like to see is the creation of new pairs for tokens that bring real utility to the OP ecosystem — Tarot can act as an accelerant for them without their going to OP Governance for support. We’ve seen some success in their supporting new lowcap projects (e.g., Layer2 Dao, Optimism Prime) to further encourage liquidity provision in those tokens. This is a value multiplier for new projects that would otherwise have to resource the same LPing.