Ripple CTO Explains How to Burn LP Tokens on XRPL AMMs

The Ripple CTO David Schwartz recently revealed an avenue for burning liquidity provider (LP) tokens for any AMM on the XRP Ledger (XRPL).

The prospect of incinerating LP tokens has emerged as a significant topic following the introduction of native AMM functionality to the XRP Ledger. Notably, the XRPL is now home to 193 AMMs less than three weeks after the AMM functionality went live.

DepositAuth Flag on XRPL AMM Accounts

As adoption sees a marked uptick, discussions around the burning of LP tokens have taken center stage. Schwartz’s explanation came in response to a community dialogue concerning the DepositAuth flag’s role in AMM accounts. 

For context, the DepositAuth flag is a security feature on the XRPL that, when enabled, prevents any unauthorized transfers to an account, including XRP and other tokens. This means that only pre-approved accounts can send funds, or the account itself must initiate a transaction to receive funds.

In a post on X, Neil Hartner, a senior Software Engineer at Ripple, called attention to the fact that the AMM accounts have the DepositAuth flag, preventing the transfer of XRP or any tokens to these accounts. Consequently, this also precludes AMM accounts from receiving token airdrops from issuers.

TIL: AMM accounts on the XRPL have the DepositAuth flag set which means no one can send XRP or token payments to these accounts. It makes sense to avoid accidental payments. But also means an AMM account can never receive token air drops from issuers. https://t.co/YmkTWhp4BL pic.twitter.com/rQvVxLnREf

— Neil Hartner (@illneil) April 6, 2024

Prospect of LP Token Burns

The discovery sparked mixed reactions. Particularly, XRPL validator TheShillVerse questioned whether this restriction extends to the transfer of LP tokens to AMM accounts, suggesting that such a mechanism could serve as an ideal method for burning LP tokens.

Notably, LP tokens are proof of a user’s contribution to liquidity in an AMM. When a market participant deposits any asset to provide liquidity to the pool, he receives LP tokens which represent his share of the pool. The market participant can then use these tokens to reclaim the initial investment into the pool as well as any accrued fees or rewards. 

TheShillVerse’s remark explored the possibility of burning these LP tokens by sending them to the AMM accounts. Shortly after the suggestion, Hartner attempted such a transaction in a testnet experiment, but confirmed that deposit permissions stopped the transfer from going through. 

This prompted further inquiries from TheShillVerse, who pondered the implications for projects claiming to burn LP tokens. He speculated that such projects would need to retain the tokens in a wallet and subsequently render the wallet inaccessible, potentially resulting in the loss of the tokens.

Ripple CTO Provides Alternative Avenue

In a clarifying statement, the Ripple CTO addressed the community’s curiosity by outlining an alternative approach to burning LP tokens.

Schwartz clarified that burning LP tokens could be achieved through overpayment in slot auctions, a process where LPs bid to get trading fee discounts. By overpaying, users can effectively remove LP tokens from circulation, and ensure the pool’s valuation remains accurate.

You can burn LP tokens by overpaying in the slot auction. You should do it this way because you want to ensure the pool valuation is correct.

— David "JoelKatz" Schwartz (@JoelKatz) April 7, 2024

Hartner concurred with Schwartz’s explanation, noting that transferring LP tokens to a burn account would indeed remove a portion of the assets from the liquidity pool. However, he pointed out that such an action would not increase the share of the remaining providers in the pool’s assets, rendering the process rather futile.