Note: This excerpt is the third article of the series “Explaining the Pilot Protocol”. Read the previous article “A Nosedive into Pilot Protocol”.
In the last article, we revealed that the protocol’s earnings get sent to an Index Fund, which maintains the value of the native token.
We can now explore its inner mechanism to understand how this Index Fund encapsulates the goal of Unipilot and why it is a crucial feature.
Furthermore, we will also expand on how the holders of the $PILOT tokens can make their voices heard and influence key aspects of the protocol.
Finally, we will cover the possible strategies of malicious users would be and how the protocol will deal with them.
What is the index fund, and how does it work?
The index fund will serve as a repository for the fees earned by the Unipilot protocol, its primary purpose will be to underpin the value of the $PILOT token.
It will be a separate smart contract that is connected to the protocol to accumulate tokens. The more fees the protocol generates, the more the Index Fund will accumulate tokens and grow in value. Users will then be able to interact with it directly to access the tokens held within it.
Here are how the two stages of the Index Fund will work:
Accumulating tokens (protocol à Index Fund):
Tokens are accumulated into the Index Fund from the protocol when LPs withdraw their earnings(fees), these can be in two forms:
1. Vault fares:
When an LP wants to withdraw the fees generated while staying in the Pilot protocol, they’ll have two options.
a) When an LP chooses to withdraw their LP fee tokens, there will be a 15% fare on the fees generated (current rate, which can be changed through governance) of their fee tokens will be sent to the Index Fund.
b) When an LP chooses to claim their fees in PILOT tokens, they’ll receive 95% of their fees in PILOT tokens, while the fees generated will be sent to the Index Fund.
2. Burning PILOT tokens (Index Fund à User):
The only way for users to access the tokens held in the Index Fund is by burning their PILOT tokens.
A percentage of the PILOT token supply can be burned to access the same percentage of tokens in the index fund supply.
- The index fund holds $10m worth of various tokens accumulated from “Vault fares” and “LP fees”.
- These tokens are: $1m LINK, $3m UNI, $6m USDC.
- “John” would like to access these tokens in exchange for his PILOT tokens, of which he holds 0.1% of the supply.
- If John interacts with the index fund and burns all his tokens, he will be eligible to receive 0.1% of the supply of the index fund ($10,000 worth of various tokens).
- He would receive: $1000 LINK, $3000 UNI, $6000 USDC
How will it affect the PILOT token price?
The 1:1 ratio of burning PILOT to receive Index Fund tokens will present opportunities for arbitraging between the index fund and exchanges, as the value and price diverge between the two.
If the value of PILOT tokens (value of total supply) decreases relative to the total value of the Index Fund, then holders will be incentivized to burn their PILOT at a 1:1 ratio to receive Index Fund tokens with a higher dollar value. Moreover, the token’s value will not be able to fall below that of the underlying assets in the Index fund.
As long as there is a delta between the two values, the burning will continue until the PILOT token value matches that of the Index Fund. Furthermore, this ensures that a rising Index Fund will also lift the PILOT token’s value by the same mechanism. Essentially, this will allow the Index Fund to become a collateralized backstop for the PILOT token, as its price will become pegged to it.
- Initially, the total value of the Index Fund and the market cap of PILOT are equal at $10M
- The Index Fund accumulates tokens and grows in value to $15M in a short period of time
- “Sarah” wants to take advantage of this delta and profit from it, she holds 0.1% of the supply of PILOT worth $10,000
- If she interacts with the Index Fund and burns all her tokens, she will receive 0.1% of the Index Fund tokens worth $15,000
In theory, as more people take advantage of this difference, the continuous burning of the PILOT supply and the reduction in the Index Fund supply will cause both values to reach parity.
Consequently, raising the value of PILOT from its initial position.
What is the reasoning for an Index fund?
The index fund is another feature that separates Unipilot from other liquidity optimizers. It aligns the incentives of the protocol with its users, as the value of its native token will be dependent on the success of the protocol.
The more people that use Unipilot to provide liquidity, the more the index fund will accumulate tokens and grow in value. This, in turn, will reinforce the price of $PILOT token as the token burning will bolster its value proposition.
Consequently, the Index fund can be thought of as the final piece in a positive feedback loop. The success of the protocol through high usage and fee generation will be captured and used to directly impact and increase the value of the native token.
Subsequently, a valuable PILOT token will facilitate better rewards for the “Captains” and more LPs choosing to receive the native token as their earnings, this, in turn, will drive up the usage of the protocol.
Let’s talk about Governance
What can be voted on and how much say will voters have?
Holding the PILOT token also grants users the opportunity to take part in the “Decentralized Governance” of Unipilot. With their tokens they can vote on key aspects, such as changing the “Vault Fare”, changing the reward percentages for “Captains” or even making tweaks to how the protocol readjusts liquidity ranges.
There is no minimum amount required for voting, even holding one PILOT token will be sufficient.
PILOT holders will also be able to vote on the future direction of the protocol, e.g. choosing between two development paths to go down or the implementation of one feature over another. In addition to this, there will also be a foundation fund making up around 35% of the supply and its resources will be at the full discretion of the voters.
All these measures ensure that the Unipilot protocol will ultimately be indebted to the holders of the token and not any other third parties.
Safeguarding the protocol
Possible attack vectors
In order to be sustainable, the protocol is set up in a way where only those who put something in can get something back in return. The universal and permissionless nature of Unipilot means that anyone can deploy a Vault, contribute to its maintenance, and be rewarded for their efforts without needing to be whitelisted. However, this does open up the possibility for a minority who are looking for loopholes in the system to get back more than they put in.
This can be observed in malicious users who can try to drain the “Concentration Incentives” in the following way:
1. Deploy a Vault for a token pair with a very low amount of liquidity
2. Cause a drastic price change in that liquidity pool, with a single trade on Uniswap
3. When the price fluctuates greatly (by 30–40%), initiate a readjustment transaction on Unipilot
4. Profit from the PILOT rewards for bringing the liquidity back into the optimal range
Possible attack prevention
The prevention is simple, we will always make sure that the premium is always less than the gas fees of a swap.
If a malicious user attempts to manipulate the price of an asset by sending it out of range through a swap transaction and then calls a readjustment function to alter the price range, he would have to pay more in terms of gas fees than the amount of premium he earns for playing a similar role to that of a captain.
Although the protocol offers anyone the ability to provide liquidity and deploy a vault to earn trading fees, it only enables the $PILOT token fee withdrawal option to whitelisted pairs to prevent worthless projects from entering the system.
The team will whitelist top token pairs at launch and in the future, $PILOT token holders can vote to whitelist any additional token pairs.
What we have learned so far
The Index Fund amplifies the success of the Unipilot protocol as it captures the value created from people using the protocol and returns it to the token that powers the ecosystem. The protocol employs a governance model that ensures that its token holders will be at the front and center of future developments and will also have power over changing the current decisions.
The Unipilot protocol also takes security very seriously and has contingency plans in place for possible attack vectors and penalties for “bad actors” that benefit the protocol.
In the following article, we will look into an exciting new feature that is only possible with V3 and coined by the Unipilot team as “Flash Liquidity” and how it unlocks new avenues for generating income.
Stay tuned for more.