Liquity's Chicken Bonds: Will They Fly?

Bootstrapping liquidity is a challenge that many protocols face at some point in their existence. Typically, protocols distribute their “precious” governance tokens via liquidity mining programs to attract capital. However, these incentive programs are often expensive and ineffective in retaining liquidity over the long run. When rewards start to taper off, mercenary capital leaves to a more lucrative yield farm, leaving the liquidity pool no better off than before.

In response to this issue, Olympus DAO and Tokemak both individually developed mechanisms to accumulate protocol-owned liquidity (POL) — i.e., liquidity controlled and retained by the protocol as opposed to the unpredictable and fleeting liquidity owned by users. Yet another solution in the market is “chicken bonds” — a bonding mechanism developed by Liquity Protocol and currently applied to Liquity’s LUSD token. In this report, we will be exploring how chicken bonds work and their traction thus far.

What Are Chicken Bonds and How Do They Work?

Chicken bonds are a bonding mechanism that can be applied to yield-bearing tokens to bootstrap protocol-earned liquidity while boosting yields for bonders. The enhanced yield on boosted tokens is derived from yield generated on liquidity owned by the protocol as well as liquidity from users bonding underlying tokens to newly issued boosted tokens.

Let’s illustrate the chicken bond mechanism with Liquity’s example. A user can create an LUSD chicken bond by depositing LUSD into the chicken bond system. After this, the bond position accrues a virtual balance of boosted LUSD tokens (bLUSD) over time. bLUSD offers a boosted yield compared to LUSD deposited into the stability pool. The longer they bond, the more bLUSD accrues, according to a smooth plateauing curve up to a cap (defined here). At any time, a user can choose to cancel their bond and ge