# Protocol-Owned Liquidity Pools

## Introduction

The Endgame Plan seeks to increase Maker's exposure to staked ETH assets. This proposal presents a way for Maker to achieve this goal and improve other aspects of the protocol simultaneously.

The main motivation is the following: Price oracles can be replaced by liquidity pools if the liquidity is guaranteed to remain there under stressful market conditions. When the liquidity is supplied by the protocol, the liquidity is guaranteed to remain there until Maker Governance moves it.

We present a modified design for liquidity pools -- known as Protocol-Owned Liquidity Pools (POLPs) -- that removes the need for oracles and offers several additional benefits. It allows Maker to offer vaults using LP tokens as collateral. These vaults can potentially charge lower stability fees to compensate the vault owners for their exposure to impermanent loss. Unlike existing LP token vaults, this design also allows Maker to carry out instant liquidations without any auctions.

In this document, we will consider stETH although the idea here should be generalized to include a generic staked ETH asset or EtherDai.

## Protocol-Owned Liquidity Pool (POLP)

A POLP is a modified Uniswap v2 pool consisting of stETH and Dai but with additional permissions that allow single-sided token withdrawals under certain conditions and the ability to freeze the pool during Emergency Shutdown.

The price of stETH in Dai is given by the ratio of stETH to Dai in the POLP and we call this the POLP price. Once sufficient liquidity exists in the POLP, there is no need for a stETH oracle.

### Initial setup

The protocol acquires some stETH using the system surplus. The stETH is deposited into the POLP with Dai also from the system surplus according to the current stETH price. The LP tokens are stored in the Pause Proxy. After it is established that the liquidity is sufficiently deep, the initial setup is complete.

It is possible to change the intial setup by, for instance, minting Dai to deposit into the POLP. Such variations should be analyzed by Risk to determine if it is prudent to do so and if the risk of unbacked Dai is sufficiently low.

### Price of stETH changes

If the price of stETH drops, more stETH is acquired at cheaper prices by the protocol. The assumption is that in the long term, the price of stETH will increase. When the price of stETH increases, the protocol effectively sells stETH for Dai at a higher price than it was bought.

## POLP token vaults

The POLP allows Maker to offer new vaults using POLP tokens as collateral. This would be similar to Uniswap LP token vaults but because the POLP has additional features, these can be used to create a simpler product.

#### Opening a vault
Users can use their POLP tokens as collateral to mint Dai. Users first deposit stETH and Dai in a 50-50 ratio based on current POLP price into the pool or buy POLP tokens directly from the market. They then mint Dai by using the POLP tokens as collateral.

#### Closing a vault
When a user wishes to close their vault, they repay the Dai and receive their POLP tokens back.

#### Liquidation
This section assumes that liquidations are instant (no OSM delay) and that users who are liquidated receive no collateral back. These assumptions can be relaxed and are only made here to simplify the concept.

Liquidation occurs based on the POLP price. If the user's POLP tokens drop in value leading to an undercollateralized vault, anyone can permissionlessly call a function that does two things:
1. Burn the POLP tokens belonging to that vault.
2. Remove Dai equal to the outstanding debt from the POLP and burn it. The slippage incurred is effectively a liquidation penalty.

Notice that liquidations do not need to go through an auction process and are instantly settled.

#### Emergency Shutdown
After Emergency Shutdown has been triggered, the POLP is usable in one direction - to convert Dai to stETH. Dai holders are given a pro-rated amount of the remaining stETH in the POLP.

Vault owners get a pro-rated amount of stETH depending on how many POLP tokens they hold.

Dai in the POLP can never be removed after Emergency Shutdown. This replicates the locked-in price behaviour of Dai during Emergency Shutdown under the current design.

## Advantages and Disadvantages
Advantages:
- No need for a price oracle. The POLP automatically tells us the price of stETH in Dai.
- Instant liquidation auctions. By taking Dai from the POLP and burning it during liquidations, we avoid the need to auction collateral. This makes it far less likely that the protocol has bad debt and one can have a lower collateralization ratio.
- Collective liquidations leading to gas savings since all undercollateralized vaults can be liquidated in one transaction.
- In addition to normal trades, liquidations will unbalance the POLP. Users are more incentivized to provide liquidity to the POLP than to a Uniswap ETH-Dai pool due to the added volume here.
- Maker has exposure to stETH and earns additional LP income.
- A similar design can be used for Elixir and remove the need for oracles and liquidations in MKR vaults and potential MKR-Dai LP vaults.

Disadvantages:
- Large amount of slippage in the POLP due to liquidations can lead to incorrect POLP prices and liquidation cascades. This is not too different from the `hole` parameter, which prevents too much collateral from being liquidated at once.
- Things I haven't thought of yet ;)