SIP 276 aims to cap SNX supply at 300 million and effectively end inflationary SNX rewards for SNX stakers.
Synthetix is beginning to shift its focus from bootstrapping the protocol’s liquidity, to building a sustainable revenue generation protocol that will share its revenue with its users.
SNX stakers are set to lose over 44% of their staking APY in approximately 10 weeks, which has led to Synthetix proposing the introduction of new staking incentives in the form of eSNX and a veSNX gauge for Synthetix V3.
Introduction: SIP 276 Context
Synthetix currently has unsustainable inflationary SNX rewards that require governance intervention. The goal of these inflationary SNX rewards was to strategically attempt to increase the percentage of staked SNX. However, the recent inflationary proposals (SIP 202 and SCCP 196) have not meaningfully increased the percentage of staked SNX. SIP 202 introduced a target staking ratio mechanism, and SCCP 196 capped weekly SNX rewards to SNX stakers at 2.23 million SNX. As a result, Synthetix is reversing course and stopping its inflationary rewards.This past week, Kain Warwick, the founder of Synthetix, introduced SIP 276 to cap SNX’s maximum supply at 300 million. This proposal is an effort to stop the inflationary SNX weekly rewards from being further distributed to SNX stakers. At the time of the proposal, the total SNX supply was 293.3 million SNX. After this week’s inflationary rewards, the remaining 6.7 million SNX will be minted and distributed as inflationary rewards over the following 10 weeks.
The importance of this proposal extends beyond the proposal’s tongue-in-cheek rationale of the number 300 being “very memeable.” The number refers to the Synthetix team calling its community members Spartans and its council being named the Spartan Council. Let’s explore how Synthetix got to this point, and what the ramifications of the proposed 300 million supply cap means for Synthetix.
Atomic Swaps Impact
On May 10, 2022, the Mirarch release introduced the implementation of SIP 198: Update to Atomic Exchange Function. This proposal changed how the prices of Synthetix trades are settled on Ethereum Mainnet, but not Optimism because there is no fee reclamation due to the speed of the oracle latency on Optimism. The proposal would remove the 10-minute fee reclamation waiting period for Ethereum Mainnet Synthetix trades. It would also implement Atomic Swaps to allow those trades to settle much faster. The upgrade uses a combination of Chainlink and Uniswap V3 oracles to protect traders from latency attacks and create a better Synthetix trading experience.
For better or worse, the Atomic Swaps integrations from 1inch and Kwenta have led to a large increase in trading volume on the Synthetix protocol. This increase can primarily be attributed to latency attacks, which frontrun trades to get the best prices to make profitable trades and significantly increase trade volume. Soon after the Mirarch release, 1inch integrated Atomic Swaps, and the increase in Synthetix’s daily trade volume grew from $1–12.6 million to $100–200 million. With increased volume, an estimated $326,000 in trading fees was accumulated daily with a portion being allocated to the weekly SNX stakers rewards in the form of sUSD rewards.
Fast forward a couple of months, a Synthetix Core Contributor acknowledged that 99% of the Kwenta trading volume is attributed to latency attacks. Kwenta is a decentralized derivatives trading platform on Ethereum Mainnet and Optimism. It offers real-world and on-chain synthetic assets through Synthetix. Kwenta’s Synthetix trading volume on Ethereum Mainnet over the past six months was $2.48 billion, and over the past 30 days, it was $1.1 billion. Thus, 44% of Kwenta’s Synthetix trading volume on Ethereum Mainnet from the past six months occurred in the past 30 days. When Kwenta integrated Atomic Swaps in early August, maximum extractable value (MEV) traders gained another option to boost Synthetix trading volume. However, if SCCP 224 passes on its revote, Kwenta’s daily trade volume could revert back to as low as pre-Atomic Swap levels of $20,000–30,000. A decrease in volume can be expected as the opportunities for the latency attacks that are currently boosting Synthetix trade volume will be reduced. Although latency attacks are usually not a positive, they have helped increase Synthetix trading volume and in turn, increased trading fees (sUSD Rewards). This increase in sUSD rewards incentivizes SNX stakers to continue to stake once the inflationary SNX rewards end.
The Synthetix community sentiment regarding the inflationary rewards has been unsurprisingly negative, due to SNX tokenholders being discouraged by the downward pressure on SNX. The Synthetix team responded by proposing SIP 276 to stop inflationary SNX rewards. Although the capping of SNX supply was set to end in March 2023, the Synthetix team has increased the timeline by six months. Assuming SIP 276 passes, Synthetix will have solved the SNX inflation issue but not the latency attack issue. The Synthetix team seems to be intentionally allowing the latency attack issue to persist since latency attacks lead to higher trading volume and increase sUSD rewards for SNX staker.
SCCP 224 failed its first pass at governance. The failure signals that the Spartan Council does not want to lower the maximum volume per block on all Atomic Swaps, which would effectively decrease latency attacks. The proposal is currently up for a re-vote, reintroducing the question of whether Synthetix prioritizes toxic volume for the sake of incentivizing sUSD rewards via trade fee sharing.
As acknowledged in SIP 276, several inflation proposals were recently passed and implemented, such as SIP 202 and SCCP 196. The goal of these proposals was to increase the percentage of staked SNX by raising the inflationary rate of the SNX weekly rewards. SIP 276 stated that the inflationary SNX weekly rewards were measures to bootstrap the Synthetix protocol and are no longer necessary. The current trading volume would be sufficient to build the protocol into a sustainable revenue generating protocol.
Where does Synthetix go from here?
Synthetix will focus on building a sustainable revenue generating protocol to continue distributing sUSD rewards derived from Synthetix trading fees. Given that the collateralization ratio (C-ratio) is currently at 400%, Synthetix isn’t the most capital-efficient protocol for smaller traders. Trading on Synthetix has historically been attractive for whales who are trading large dollar amounts of tokens since Synthetix debt pool offers lower slippage and lower fees than other DEXs.
Kain stated in his Synthetix L2H2 blog post that he believes the sustainable revenue generation narrative will be the next DeFi narrative. Given Kain’s ideas, Synthetix will likely focus on growing its product offerings to maximize revenue generation and share this revenue with its users. Synthetix has signaled that it is moving forward with sustainable revenue generation and revenue distribution in the Synthetix V3 proposals, despite the risk of the SNX token potentially being deemed a security for doing so.
Synthetix V3
The announcement of Synthetix V3 created a buzz on Twitter in July 2022, initiating conversations regarding the future of the Synthetix protocol. Synthetix V3 outlines the long-term vision of permissionless asset creation, improved credit control, and Liquidity as a Service (LaaS). With Synthetix offering LaaS, the protocol intends to attract more builders by solving the cold-start liquidity issue that new protocols often encounter. However, given the density of LaaS offerings, Synthetix will need to design a unique value addition in order to attract new protocols to bootstrap liquidity via Synthetix. One initial advantage Synthetix brings to LaaS is a recognized reputation amongst the DeFi ecosystem, having built a brand trusted by the DeFi community for several years.
If SIP 276 succeeds and is implemented, a dip in users staking SNX can be expected, as they face a 44% loss in staking rewards in 10 weeks. Synthetix has accounted for this possibility in SIP 305. SIP 305 introduces a new staking incentives reward token, eSNX. The details suggest that users will be able to stake SNX in a new SNX vault of a Preferred Fund. A veSNX gauge was also mentioned, but no further details were released on the time or methods of the implementation.
Conclusion
After the community outcry spanning multiple proposals caused downward pressure on SNX, the Synthetix team responded and fixed their inflationary rewards problem. In 10 weeks, the weekly SNX staking rewards will disappear, leaving the sUSD rewards as the only SNX staking incentive until Synthetix V3 launches, potentially bringing new staking incentives (eSNX and veSNX). SIP 276 can be seen as a conscious decision from Synthetix team to shift its focus from bootstrapping the protocol through inflationary rewards to aligning with Kain’s vision of a sustainable revenue generating protocol, capable of distributing revenues to its stakers, despite the risk of legal issues.
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Prior to joining Messari as a Governance Analyst in May of 2022, Joel was a protocol lead for RabbitHole’s Metagovernance Pod. Joel has a Bachelor of Commerce degree from the University of Manitoba.
Prior to joining Messari as a Governance Analyst in May of 2022, Joel was a protocol lead for RabbitHole’s Metagovernance Pod. Joel has a Bachelor of Commerce degree from the University of Manitoba.
