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Liquidity Vaults (LVs) are decentralized liquidity financing tools for pre-launch stage Web3 protocols. It enables Web3 protocols to access much-needed liquidity for their future tokens with a mix of off-chain crowd Simple Agreements for Future Tokens (SAFTs) and on-chain smart contracts. LVs don't require token issuance by the time of financing and can operate based on the premise of future tokens. The raised capital can only be utilized for future initial liquidity deployment so that pre-launch stage Web3 projects focus on building their product and community, not the initial liquidity.
After the initial liquidity provisioning, the liquidity raised by LVs will be locked for a minimum of 6 months by the verifiable liquidity locker smart contracts so that investors can access a trustless trading environment. The AMM LP tokens will be vested to secure a deep liquid market over time.
LVs require pre-defined deal terms, such as the estimated token launch date (TGE), discount rate, and valuation cap, so that investors inject their capital with predictable token metrics. If there are misaligned or malicious acts on the deal terms, investors can always get 100% of their initial investment.
Similar to the SAFE note, LV is a form of a convertible note with pre-defined maturity dates and triggering events. Typically, SAFE notes convert in the first-priced financing rounds in equity financing. In LV notes, the triggering event is the public token launch date. Hence, public FDV is used as a baseline valuation.
For example, let's say protocol X is a pre-launch stage project that will launch a public token in the future, but the date and exact token metrics are not finalized. Protocol X must provide the following deal terms to ensure aligned liquidity raising.
- Latest TGE date: 10 months after the LV investment
- Discount rate: 50%
- Valuation cap: $10m
In written terms, the $X token has a maximum of ten months to launch its token publicly. The LV will be converted by either a trigger discount rate or valuation cap, depending on the FDV. If protocol X decides to launch with a $15m FDV, then the discount rate applies, and LV converts into tokens with a $7.5m valuation. The conversion is based on whichever provides a lower valuation. In this example, since the valuation cap is $10m and the discount rate provides a $7.5m valuation, LV positions are converted by the discount rate. However, suppose protocol X decides to launch with a $30m FDV. In that case, the valuation cap converts the LV as it provides more favorable deal terms and protects early backers from inflated valuations.
Hence, at the token generation event, LVs will be converted into tokens and must be distributed based on the converted amount.
If Web3 protocol fails to follow the requirements from token metrics to deal terms, investors will always get 100% of their initial investments back, as this capital is fully locked until the public token launch.