HI Yoloers，
We are glad to announce the next protocol, YoloSwap.
There is no doubt Uniswap is the most successful in the digital currency space after Bitcoin and Etherium. Along with the success of Uniswap, the concept of Automatic Market(AMM) becomes very popular.
However, Uniswap didn’t become popular on the first day. In order to make AMM work, liquidity providers(LP) are needed. To attract LPs, Uniswap has to redistribute the swap trading commissions mostly to LPs. In the cold winter of digital currency between 2017 and 2019, it’s not a bad way for people to make a few bucks while hoarding tokens. Entering 2020and 2021, because of the halving of bitcoin, all digital token prices went up. The LPs discovered their total asset values decreased comparing with hoarding tokens doing nothing. The little secret is Impermanent Loss.
What is Impermanent loss?[1]
It is the loss caused by AMM cannot adapt to the common market price by itself and has to rely on arbitragers. The loss from LPs is earned away by arbitragers. AMM cannot live without arbitragers. Arbitragers are the core part of the ecosystem. Impermanent Loss is also a major barrier for Uniswap development.
The trading fees can cover this loss if price fluctuation is low. If the price fluctuates a lot, the loss will be big. Their relationship can be described by this function and curve.
divergence_loss = 2 * sqrt(price_ratio) / (1+price_ratio) — 1
From this chart, we can see its convexity function and it’s a fragile system according to Taleb The price moving up and down will cause the same loss to the LPs. Only when the price doesn’t move, LPs can gain trading fees. But, the token prices are notorious for valatility.
Why will LPs join the game economically irrationally?
The only possible reason is the trading fees that can cover the loss. This article[2] argues a linear 11% growth of trading volume can produce enough trading fees to cover the loss. However, how can a two hundred million dollars pool sustain 11% growth? Furthermore, the impermanent loss, also called divergence loss, is closely related to the correlation of two assets in the pool and the trading fees are closely related to trading volumes and the number of liquidities[3].
A lot of solutions have been proposed to solve immperment loss on AMM?
Since Impermanent Loss only happens when the trading pairs price diverges, some people only suggest providing liquidities to the constant price ratio of trading pairs, among which the stablecoins swap is the most popular one. [4] Bancor V2 suggests using ChainLink as outside Oracle to adjust the pool weight.[5] Balancer suggests using customizable weight for each token to reduct the potential loss exposure.[6] KittenSwap uses a dynamic weights suggested in [7]
YoloSwap is here to propose a new solution.
LPs are like shareholders of the company. The revenue stream would be trading fees. The imperment loss is cost of doing business. We simulate the LPs as the stock value. Therefore, we can use all the financial engineering models to hedge our LPs’ risk.
Here we go.
Uniswap can be generalized into Constant Product Market (CPM). According to [8][9], the portofolio value can be described as
which could be replicated as
If we choose interest rate r = 0, and A=m0, we can convert into
While [9] and [10] use those models to use LP share values to replicate different trading strategies like options, we believe we can use the same strategy to hedge the risk of imperment loss.
We argue that LP shares will be like company equity shares. We imagine that in the future people will trade LP tokens just like trading stocks and will use LP tokens in lending as well. A scientific method to value those shares and hedge their risks are necessary. YoloSwap strives to solve those problems in this space.
Finally, our plan is being implemented step by step, keep following Yoloers.
— — — — — — —
reference
— — — — — — — -
[1] https://medium.com/@pintail/uniswap-a-good-deal-for-liquidity-providers-104c0b6816f2
[2] https://medium.com/@pintail/understanding-uniswap-returns-cc593f3499ef
[3] https://alfablok.substack.com/p/coming-soon
[4] https://tokentuesdays.substack.com/p/eliminating-impermanent-loss
[5] https://blog.bancor.network/beginners-guide-to-getting-rekt-by-impermanent-loss-7c9510cb2f22
[7] https://www.kittenswap.org/
[8]https://arxiv.org/abs/1911.03380
[9]https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3550601
