IEO Information | Understanding the Operational Logic and "Token Economic Model" of Mercurial Finance in One Article

This article is provided by FTX and authored by James Chiu

FTX exchange will conduct an IEO for Mercurial Finance this Thursday (5/13), marking FTX's eighth IEO project to date. Mercurial Finance is a "dynamic vault" protocol based on the Solana blockchain, aiming to bring more synthetic assets into the Solana ecosystem, create liquidity, and link the efficiency of funds across protocols.

Mercurial Finance is a "multi-functional" DeFi protocol on Solana, with the first "dynamic vault" centered around stablecoin assets, integrating stablecoin exchange protocols, synthetic protocols, and yield aggregation. To provide a clearer picture, Mercurial Finance can be likened to Curve + Synthetix + Yearn.

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The operation logic involves the first layer of Mercurial being the stablecoin exchange protocol, with the second layer being the Yield Program.

Users can earn profits by collateralizing stablecoins like USDC or mUSD, a stablecoin synthesized by collateralizing SOL, SRM, MER, in either the stablecoin exchange protocol or the Yield Program. The revenue from the stablecoin trading protocol comes from a portion of trading fees + governance tokens.

The Yield Program connects with external DeFi protocols (approved by Mercurial DAO), such as lending protocols, flash loan protocols, to earn "interest on loans." With the development of the Solana ecosystem, stablecoin lending will increase, enhancing the yield of the Yield Program, allowing users to earn more rewards.

The whitepaper states, "Since the platform token is already collateralized in the vault when synthesizing mUSD, users can earn double profits by collateralizing mUSD in the vault."

The Four Functions of Mercurial Finance

Trading Protocol

The trading function is the core business of Mercurial Finance. In general AMM (Automated Market Maker) protocols, as the price range widens, the slippage increases. Liquidity providers (LPs) not only lose their principal when the price falls, but they are also forced to add more capital, increasing their losses. Conversely, when the price rises, they are forced to reduce their holdings, decreasing profits.

The developers of Mercurial have added a feature to their established AMM algorithm where liquidity providers' earnings are adjusted based on price volatility. The higher the volatility and transaction fees, the higher the earnings for LPs. This helps hedge against impermanent losses.

Additionally, benefiting from Solana's high efficiency, Mercurial Finance's on-chain algorithm can dynamically adjust parameters such as volatility fees and loan liquidity. Therefore, compared to other AMMs, it can offer slippage as low as 100x.

Yield Program

As the Solana ecosystem grows, stablecoin lending will also increase exponentially. According to the whitepaper, after external protocols are audited by Mercurial DAO, Mercurial's yield farming pool can connect to external protocols such as lending protocols and flash loans. It allocates funds to external vaults through an "on-chain algorithm" to earn lending income.

Token Economic Model

The governance token of Mercurial Finance, MER, has a total supply of 1 billion tokens.

Token Utility

According to the whitepaper, the MER token has the following four functions: governance participation, voting for new synthetic assets, liquidity mining, and an insurance pool.

Governance Participation: As mentioned earlier, Mercurial can change "dynamic parameters" such as transaction fees and fund sharing, and MER token holders are the group that controls these parameters through voting.

Synthetic Asset Voting: MER holders can vote on new stable synthetic assets or collateral assets.

Liquidity Mining/Community Rewards: Incentives for liquidity providers and community building.

Insurance Pool: To prevent stable asset disconnection (very low probability), a portion of MER is used as collateral for stable assets.

Positive Cycle of MER Token

Since MER is used as a mining reward, there is an incentive to collateralize assets in the Mercurial vaults, increasing the volume and depth of the Mercurial vaults.

It is worth noting that in order to encourage users to hold MER tokens long-term,

besides receiving a portion of trading fees and fund profits, MER holders can also use MER to participate in changing dynamic parameters and voting for synthetic assets. Additionally, MER is essential collateral for synthetic assets, which increases the incentive to purchase and hold MER tokens long-term.

On the other hand, as the synthetic assets increase, more MER will be locked in the insurance pool, reducing the market supply and increasing the possibility of token price appreciation, creating a positive cycle once the MER price rises.

User collateralizes assets → Receives MER tokens → Increases the volume of the fund → Increases income from lending, flash loans, stablecoin trading → MER holders receive more profit sharing → MER price increases → Liquidity mining APY increases → Incentive for users to collateralize assets increases → Increases liquidity.

Once there is enough incentive (high APY), it can attract both on-chain and external funds, further increasing Mercurial's liquidity and reducing trading slippage.

Mercurial Finance: An Essential Puzzle Piece in the Solana Universe

According to the whitepaper, users can collateralize platform tokens such as SOL, SRM, MER, etc., to synthesize stable assets, adding value to Solana's ecosystem tokens and improving capital efficiency.

It is worth noting that the stablecoin trading, flash loans, and synthetic asset functions provided by the Mercurial protocol are currently absent on Solana. As the Solana ecosystem develops, stablecoin trading and lending activities will grow exponentially, increasing the demand for stable assets, effectively complementing Solana's ecosystem.

Capital efficiency is the most important indicator for evaluating the DeFi ecosystem. It is easy to see that the Solana ecosystem (SRM, FIDA, RAY, MAPS, OXY) has been working on this. While Raydium, Maps.me, and Oxygen mainly improve the efficiency of users' own funds, Mercurial Finance improves the capital efficiency of DeFi platform assets.

Imagining Synthetic Asset Protocols

In theory, Mercurial Finance can synthesize any asset by collateralizing MER, although initially limited to stable assets. However, as the volume grows, Mercurial Finance will have other financial derivative synthetic assets, such as "equity synthetic asset trading."

In the Solana ecosystem, Serum DEX is the best place to trade these synthetic assets. Through Serum DEX's order book mechanism, traders can use CEX-like order placement mechanisms and avoid slippage during trading, significantly improving the trading experience for synthetic assets.

Currently, Mercurial Finance has opened SOL and SRM as collateral for stable assets. If it opens up as collateral for other synthetic assets in the future, it can significantly increase the utility of SOL, SRM, and other assets, further enhancing the token circulation of the Solana ecosystem.

As a synthetic asset protocol, Mercurial Finance will need a high-throughput public chain and a DEX with an order book mechanism if it opens up to synthesize non-stable assets in the future. From this perspective, it is not difficult to understand why Mercurial chose to develop on Solana.

Currently, the Solana ecosystem lacks synthetic assets, stablecoin exchange protocols, and flash loan protocols, all of which are filled by the emergence of Mercurial Finance, strengthening the composability between DeFi platforms on the Solana blockchain and improving capital efficiency.