Exchange Rate
The exchange rate can be understood as a mechanism to adjust the ratio and proportion of tokens within the Vault, which serves as an integrated liquidity pool. This adjustment ensures that specific services within the ecosystem can utilize the liquidity from the Vault under optimal conditions. The exchange rate determines the quantity of MECA obtained upon deposit and the quantity of tokens obtained upon depositing and withdrawing from the Vault, based on specific equations used for deposit and withdrawal. These calculations involve the usage of 'weight' and 'need' values, which determine whether there is an excess or shortage of assets within the Vault at the current moment.
What's the purpose?
The Vault functions as an integrated liquidity pool, utilizing liquidity through various services to generate appropriate returns on asset management. To achieve this, it's crucial to maintain the liquidity ratio between tokens at an appropriate level. As market movements affect the price of specific tokens, the composition ratio of assets held by the Vault changes. If a particular token becomes overly abundant or scarce during this process, liquidity imbalances may occur, hindering smooth transactions by other services and reducing efficiency in liquidity management, thereby decreasing profits. To maximize profits by maximizing liquidity asset management across services, it's essential to maintain the appropriate proportion of tokens based on actual demand at the current moment.
How it works?
The Vault provides opportunities for market participants to perform this role in a decentralized manner by offering arbitrage trading opportunities. This incentivizes arbitrage traders with opportunities for new revenue generation while encouraging the maintenance of the optimal target composition ratio between tokens. As services utilize liquidity from the Vault, changes in token ratios and proportions within the Vault occur in response to market movements, resulting in changes in the exchange rate. When a specific service utilizes liquidity from the Vault, changes in the price of a specific token lead to changes in the quantity of each token originally held by the Vault.
So when a token's popularity increases, its quantity decreases continuously due to increased demand, while the quantity of paired tokens in the Vault increases. This leads to a decrease in the exchange rate, indicating increased scarcity of the respective token within the Vault. Along with an increase in demand for that token, the MECA amounts that can be earned increase when depositing the same quantity of that token as before. Therefore, intermittent opportunities are provided for users to obtain more MECA than usual, encouraging the procurement of tokens with increased demand from the Vault.
Conversely, when the quantity of a specific token held within the Vault increases, the exchange rate rises. At this point, the decreased MECA reward for depositing makes depositing less favorable for users, thereby discouraging further token deposits. However, the higher exchange rate implies a higher value for MECA concerning the respective token, making withdrawals significantly advantageous. This indicates an increased availability of the respective token, as users can withdraw tokens more when burning one MECA. Thus, by encouraging withdrawals and reducing demand for tokens with decreased demand through the exchange rate, the Vault maintains balance by releasing surplus tokens.
Factors
The Vault measures several factors necessary for determining the exchange rate based on the value of each asset and its proportion within the Vault. While the exchange rate fundamentally operates similarly to AMMs (Automated Market Makers), there are additional influencing factors involved, leading to varying outcomes. Therefore, to understand the exchange rate determination process, it's essential to first comprehend the factors at play.
Need
The Need metric gauges whether the quantity of an asset within the Vault is insufficient or sufficient relative to the target amount. The Need value is zero when the Vault holds the optimal amount of a specific asset, negative when the Vault's holding exceeds the target quantity, and positive when it falls short of the target. When a user deposits a specific token into the Vault, the Need value decreases due to reduced demand, while withdrawing increases demand, causing the Need value to rise.
As a specific token becomes excessively deposited in the Vault, the Need value increases. The Vault then sets the goal amount as the current balance plus the Need value. If there's an excess of tokens, the Need value becomes negative, adjusting the optimal quantity needed. With continuous deposits, the Need value increases while the goal remains constant, resulting in a continuous increase in the MECA exchange rate until the Need value is reassessed.
Additionally, the Need value changes when the token composition within the Vault shifts due to other ecosystem services. These services utilize liquidity from the Vault, adjusting the actual demand-based token quantity according to changing prices. As a result, the Need value is recalibrated, potentially transitioning from negative to positive or vice versa. This fluctuation in demand, reflected by the changing Need value, influences the exchange rate, leading to arbitrage trading opportunities using MECA.
Thus, based on market movements, deposit and withdrawal scenarios, and other complex market factors, the Need value for a specific token determines fluctuations in the exchange rate. Consequently, MECA-based trades may offer opportunities to obtain more MECA or acquire more of a specific token, depending on changes in the exchange rate. Moreover, the Need value ensures that the exchange rate can return to an appropriate level, balancing market demand through assessed Need values.
Among the services utilizing Vault liquidity, the Exchange references the prices set in each market and notifies the Vault of the target quantity for each token based on the respective market. During this process, the Need value undergoes continuous reassessment. Consequently, the Need value plays a crucial role in ensuring that the Vault maintains the target composition and ratio of tokens, thereby facilitating the maintenance of an appropriate target weight.
Weight
Weight is the value that represents the proportion of a specific asset within the Vault, encompassing both its value and quantity comprehensively. And also, the weight value also signifies the quantity of MECA circulating externally through the deposit of the respective token. Therefore, if a particular token is deposited, its weight continuously increases, and conversely, it decreases during the withdrawal process due to the burning of MECA. Essentially, weight translates any constituent asset within the vault into a certain value, indicating both its worth and how much of it exists within the vault.
The initial weight value for a specific asset is determined by leveraging the value of other assets deposited simultaneously when the asset is initially listed in the Vault. For instance, if 1 ETH is listed with 2000 DAI and 2000 USDT, and DAI and USDT each have a value of 1 MECA per unit, the weight value of 1 ETH right after listing would be 4000.
However, the weight value does not increase linearly. It varies dynamically based on the equations governing each deposit and withdrawal, taking into account the value determined through exchange rates and the proportion of the asset held within the vault. This results in a curved graph, which increases variably. This concept is akin to the notion seen in Automated Market Makers (AMMs), where the return diminishes as the exchange rate rises with the continuous buying of a specific token.
But, due to the involvement of the Need value in this process, the number of MECA one can obtain diminishes sharply with repeated deposits of unnecessary tokens. Consequently, the potential increase in the weight value also decreases significantly. This is because the value of any token is not always fixed, and it must reflect the fluctuating value based on changes in demand for the token.
The calculated weight value is utilized by other services to determine and allocate the proportion between two specific assets within the Vault's liquidity. For instance, if there are 2 ETH with a weight value of 4000 and 2000 DAI with a weight value of 2000, since the weight value of ETH exceeds that of DAI, all DAI can be allocated to ETH. However, regarding DAI, with a weight value of 2000, DAI can utilize 2000 of liquidity for any other token. Therefore, out of the weight value of 2 ETH, which is 4000, only 1 ETH, equal to 2000, can be used for liquidity concerning DAI.
However, during this process, the Need value is also considered. Therefore, merely repeating deposits to increase weight does not increase the allocation. If the weight is high for assets with a negative Need value, the Vault perceives it as a bubble. Consequently, by measuring the delta as negative Need, the actual weight to be allocated is reassessed. Thus, through this process, arbitrary manipulation of weight to artificially adjust liquidity allocation is not possible.