If you’ve been in crypto since the DeFi Summer of 2020, you’d probably be familiar with the discourse on mercenary liquidity.

To incentivize liquidity, protocols had to distribute emissions to liquidity providers, resulting in unsustainable token inflation. And if/when other protocols join the party and offer higher yields, liquidity will migrate over instantaneously.

To combat this quandary, Curve introduced veTokenomics, with protocols such as Aerodrome adopting and demonstrating its efficacy. In today’s brief, we will explore Bunni’s take on veTokenomics, and go one step further and focus on how Bunni V2 aims to revolutionize liquidity provisioning.

Bunni - the liquidity engine for Uniswap

Bunni started off by incentivizing Uniswap V3 liquidity, and it comprises two components:

1. Uniswap Wrapper: Wraps Uniswap liquidity positions from an NFT into fungible ERC-20 tokens. This provides greater composability, enabling Bunni to adopt Curve’s gauge system for Uniswap positions.
2. veTokenomics System: To be discussed in the next section.

Bunni has since undergone a protocol upgrade, and its V2 now boasts the following features for building custom Uniswap liquidity pools:

Let’s illustrate the above using a case study – providing liquidity for the ETH/USDC pair:

• Double-geometric distribution is preferred for its LDF as compared to a flat distribution, given the volatility in ETH’s price.
• Shapeshifting can be employed here with less concentrated liquidity during high volatility periods, and more concentrated liquidity during low volatility periods to reduce impermanent loss.
• Since there will be frequent liquidity distribution changes, autonomous rebalancing can be enabled.
• Rehypothecation for ETH and USDC can also be enabled using lending platforms for capital efficiency.
• am-AMM can be enabled for optimal fee setting and MEV capture.
• Surge fees can be enabled to protect against sandwich attacks during shapeshifting.

TLDR, Bunni V2 aims to attract Uniswap LPs by:

• enabling customizable and programmable liquidity,
• maximizing the capital efficiency of liquidity provided,
• and optimizing fee parameters,

to ultimately protect LPs while enhancing their yield.

veTokenomics system

Moving on to Bunni’s veTokenomics system, Bunni introduced LIT (Liquidity Incentive Token), its native token for incentivizing liquidity. This differs from Curve veTokenomics as follows:

• Balancer LP token as ve token: Bunni uses the Balancer 80LIT-20WETH LP token as the lock token for obtaining veLIT, instead of using LIT as the lock token.
• Increased max boost: Bunni gives a max of 10x boost to LPs who have veLIT, instead of the 2.5x as pioneered by Curve. This increases the advantage of holding veLIT.
• Call option as reward token: Instead of using LIT as the reward token, Bunni uses call option tokens for LIT (oLIT) as the reward token, and oLIT holders can purchase LIT from Bunni at a discount to market price. This also seeks to establish an additional cashflow stream for Bunni.

In my opinion, oLIT is perhaps the most innovative upgrade to Curve’s veTokenomics system, which would have allowed the farmer to cash out the reward token without paying anything to the protocol. But by substituting this with a call option token like oLIT, the farmer is forced to purchase LIT from the protocol when exercising the call option, and this would help accrue cashflow to the protocol.

Furthermore, the discount is a parameter that the protocol has control over. A higher discount engenders efficient incentivization, but generates less cashflow for the protocol, while a lower discount transfers more cash gains from the farmer to the protocol, but effectuates less incentivization.

Differences aside, the utility of veLIT is similar to Curve’s veTokenomics system:

• Governance voting: Vote on governance proposals such as listing new gauges, changing protocol parameters, and approving budgets.
• Gauge weights voting: Vote on how gauge rewards are distributed across different gauges.
• Boost gauge rewards: Hold veLIT to boost yield earned from gauges.
• Receive bribes for voting: Get rewarded for voting on certain gauges.
• Receive protocol revenue: Earn a share of the protocol's revenue (more on this later).

LIT - bullish or bearish?

The bullish case for LIT post-Uniswap V4 is intuitive; customizable liquidity provisioning, capital efficiency, and fee optimization attracts LPs to build Uniswap liquidity pools on Bunni V2, and with Uniswap’s orderflow being routed through Bunni, this effectively contributes to Bunni’s volume, and by extension, its revenue.

As can be seen above, Bunni’s volume has already been showing decent strength, and following the launch of Uniswap V4, this is expected to sustain. And since Bunni currently charges a 5% protocol fee on the swap fees generated by Bunni LPs, more volume = more revenue for Bunni!

Furthermore, following a successful governance vote (TRC 96) last year, 100% of Bunni’s share of swap fees will be directed to the treasury for “long-term project health”. This could potentially be used to fund other protocol initiatives such as security audits. For context, Bunni recently passed 2 proposals (TRC 128.1 and TRC 129), which requested a combined $339,300 to fund 2 smart contract audits by Pashov and Trail of Bits!

Finally, going back to the aforementioned revenue share, TRC 96 advocated for 25% of the WETH garnered from oLIT redemptions to be allocated to veLIT holders, while directing the remaining 75% to the treasury. Hence, this could incentivize the holding of veLIT, which translates to more demand for the LIT token.

But while Bunni V2 is currently one of the few projects building on top of Uniswap V4, what happens when other hook apps emerge? From DEXes organizing hookathons (Uniswap, Balancer, PancakeSwap), to the establishment of a Uniswap Hook Incubator (Atrium Academy), Bunni could be facing some stiff competition in the future.

This leads to the following quagmire – how can Bunni differentiate itself from its competitors?

After all, these hook apps will likely also enable customizable and programmable liquidity, rehypothecation, fee optimization, MEV recapture and everything in between. With no room left to outshine competitors with product differentiation, price differentiation is the next logical step, with hook apps potentially offering rewards for liquidity provisioning. Now, this begins to sound like a precursor to yet another case of mercenary liquidity we witnessed in 2020/2021.

Evaluating LIT

Admittedly, I may have grown disenchanted with DeFi ever since the bear market in 2022 when liquidity quickly evaporated to chase TradFi yields. And call me a cynic, but I believe it is near impossible for DeFi apps to establish a material moat to keep its users and liquidity sticky.

For Bunni, while the notion of providing highly customizable liquidity is novel, I anticipate a proliferation of hook apps that seek to provide the same functionality, in a bid to jump on the bandwagon.

But, at the end of the day, while Bunni may not have a clear moat, it is undeniable that Bunni (LIT) has a first mover advantage as it is one of the only investable projects that is building on top of Uniswap V4 right now.

And given LIT’s low FDV of under $20 million, a potential short-term play could emerge here, where one can bid LIT cheaply now before it gains more visibility going into Uniswap V4 launch. But given the cyclicality of DeFi, I will not treat this as a sustainable long-term hold and will instead sell it right after price discovery post-Uniswap V4 (hopefully).