💹LP token value and Fee sharing

Initially, one unit of LP token and one unit of underlying token are equivalent, meaning one LP token can redeem one underlying token, without the effect of coverage ratio. The total supply of LP tokens and the amount of liability would also be equal.

However, as the protocol generates trading fees, the total liability of token i will exceed the supply of LP token i. This will result in a gradual increase in the value of the LP tokens. For example, if there are 100 LP tokens and a total liability of 102, then the 100 LP tokens can be exchanged for 102 underlying tokens at a 1:1.02 ratio, under normal coverage.

Definition - 5.1

$$\text{LP token value against underlying token} = \frac{\text{Total liability}}{\text{LP token total supply}}$$

Before fee sharing is enabled, the fee would be accumulated in the pool without increasing the total liability. This surplus in the pool provide a buffer against extreme market conditions. It also enable a fee-less trading zone as the coverage ratio of all tokens could be higher than 100%, and therefore no fee would be charged.

After fee sharing is enabled, the liability would start increasing as trading fee is generated. The value of the LP token against the underlying token would increase. This would provide the base yield for the LPs.

Once governance is enabled, the community can decide the amount of fee charged, and the fee distribution among LPs and ve token holders.