Financial alchemy: how to increase income using Uniswap V3 liquidity managers

The launch of the third version of Uniswap has become an important milestone in the development of decentralized finance (Defi). Having popularized the mechanism of the automatic market maker (AMM) at one time, the leading Ethereum Tirge presented the market with the concept of concentrated liquidity.

Almost immediately after the platform upgrade, completely new services for the industry appeared, designed to increase the profitability of liquidity providers on Uniswap V3 and reduce the risks of inconsistent losses.

We got acquainted with such services by studying their functionality and performance indicators.

• Thanks to the radically new Uniswap V3 functions, a new type of services appeared on the market that optimize the profitability of concentrated liquidity positions.
• Despite the seemingly interesting plan and relevance, indicators of the profitability of the optimizers are low.
• Concentrated liquidity managers are exposed to various risks and work poorly during periods of high market volatility.

Features of Uniswap V3

Uniswap-leading in the volume of bidding and number of users of Ethereum turf. The first version of the decentralized platform began work on November 2, 2018. From that moment, more and more trading platforms began to appear that use the mechanism of automatic market maker (AMM) instead of the traditional book of orders.

In May 2020, the second version of Uniswap was launched, the key feature of which was the possibility of placing ERC-20 tokens in pools with any other assets of the same standard.

The main advantages of the first two versions:

• Simplicity of use – an intuitive interface that has discovered the opportunity for everyone to receive passive income from the liquidity provided.
• Compounding commissions. The commission accumulated by the providers (LP) of the commission return back to the pool, creating the effect of a complex percentage.
• Interchangeability. LP-TOKENS EXTEVIVENED BE DEARS OF LEGO Details. Such assets can be used as collateral in protocols like AAVE or MakerDao, thus increasing the efficiency of using capital.

On May 5, 2021, Uniswap launched the third version of the protocol with radically new functions and capabilities, including:

• concentrated liquidity;
• order of the limit range;
• multiple positions within the same pool.

The third version also appeared Trekhurovna structure of commissions (0.05%, 0.3%and 1%). It is designed to give liquidity providers (LP) the opportunity to choose pools in accordance with their tendency to risk . For example, a pair of ETH/DAI is more volatile than USDC/DAI, which means it involves a higher risk.

Commissions of 0.05% are mainly for steam with stablecoins. The level of 0.3% is characteristic of pools like ETH/DAI, and 1% is much more volatile couples with low -liquid assets.

Uniswap V3 liquidity providers can use capital more efficiently, choosing, in fact, individual price curves. To illustrate the work of this mechanism, suppose that Alice and Bob decided to provide liquidity to the USDC/ETH pool. Each of them has $ 10,000, and the current price of Ethereum is $ 2700.

Alice introduced 5000 USDCs and 1.85 ETH to the liquidity pools of the second version of the platform, thus sharing her capital equally between two assets.

Bob decided not to send all funds to one pool. By choosing a price range between $ 2200 and $ 3200, it deposited only 600 USDC and 0.22 ETH. The remaining $ 8800 Bob used for other investment opportunities.

Despite the significant difference in the volume of investments, Alice and Bob will receive the same commission income while the price of ETH is in the range of $ 2200- $ 3200. Choosing a new version of Uniswap and the optimal range, Bob forced his capital to work many times more efficiently.

Moreover, he significantly reduced the risks. If suddenly the price of ETH falls to $ 0, Bob will lose 12% of its capital, but Alice – all means.

To implement the concept of concentrated liquidity, Uniswap developers had to go to some compromises. For example, liquidity providers receive NFT instead of interchangeable tokens of the ERC-20 standard, representing their funds in the bullet.

“However, positions can be made interchangeable through the use of third -party contracts and partnerships. In addition, trading commissions are no longer automatically reinvested in the pool on behalf of LP, ”the uniswap blog explains.

Choosing narrow price ranges, providers subject themselves to risks of inconsistent losses inherent in AMM. Given the volatile nature of most crypto acts, the choice of the optimal range can be difficult. Capital efficiency is not easily achieved – there is always a risk that the price will come out of the range set by the user.

For example, the user has delivered liquidity to the USDC/ETH pool, setting a concentrated liquidity range between $ 2500- $ 4000. If the price falls below $ 2500, all the liquidity provided by the provider is converted into ETH. If the second in capitalization of cryptocurrency grows above $ 4000, the user will remain with USDC. In both cases, LP stops receiving commission income, subjecting itself to the costs of lost benefit.

Despite the listed shortcomings, the total turnover of the new version of the exchange is several times higher than the Uniswap V2. The difference is also noticeable in the context of individual pools, including USDC/ETH – $ 332 million against $ 305 million (as of 9.08.2021).

According to the Nansen study published in July, most users of Uniswap V3 (58%) holds only one position of concentrated liquidity. More than five such positions have been found in less than 10% of addresses.

“In total, we discovered 22,684 unique addresses that hold/held positions on Uniswap V3. A significant part (77%) of these users belongs to the category of passive liquidity providers. This means that they almost never corrected the parameters of their positions, ”the researchers shared observations.

14% of users held from one to five positions and changed them more than twice. Only 1% of providers held more than 25 positions.

Thus, only a small percentage of users adheres to a proactive approach to liquidity management. In response to the current situation, various services appear on the market designed to ensure the management of concentrated positions on Uniswap V3 with the minimum participation of the user.

The main approaches to the management of LP positions

The process of withdrawing liquidity after the release of prices from the target price corridor and the provision of funds to another range is called Rebalance. The purpose of the recently appeared services for controlling Uniswap V3 liquidity is to automate Lp positions to be redlanted. In addition to this, such services can reinvest the commission income of liquidity providers.

Native tokens of such platforms, usually the ERC-20 standard. This means that they can be used as collateral on landing services, as well as participate in liquidity mining programs.

According to the ALPHA Vaults service from Charm Finance, there are two approaches to the management of concentrated liquidity:

• Active rebalance, suggesting the exchange of tokens for subsequent placement in the new range and, accordingly, a certain commission for each such operation.
• Passive rebalance – does not imply the exchange of tokens to transfer the position to another range. Instead, two types of orders are used-basic and rebalant or “one-sided” (Single-SideDed). Orders of the first type are located symmetrically around the current price. The second type of warrant occupies a narrower range, which is close to the current price and coincides with the base. Orders parameters change every 12 hours.

“The term“ unilateral liquidity ”is not entirely clear, but inherently it is similar to a limit order, located close to the current price. Thus, if the price moves in this direction, then the second position becomes active and begins to collect LP commissions, ”the Defi Expert explained in his article under the nickname Vividot.

The example depicted above illustrates liquidity in the form of 1 ETH and 2000 USDC in the base range of $ 1500- $ 2500. When the price ranges between $ 1750 and $ 2000, a rebalant order converts the USDC excess in ETH.

According to Vividot, when passive rebalacation of the commission are not charged. On the other hand, the profitability of LP positions decreases with strong and long price movements in a certain direction. In such periods, the strategy of passive rebalance does not work, the proactive approach to managing positions becomes more attractive.

“The choice of a rebalance range is even more important than the choice of a rebalance method,” the expert emphasized.

• The best range from the point of view of capital efficiency is the most narrow and most appropriate for future prices (which are unknown);
• The choice of a narrow range is fraught with a drop in profitability during periods of increased market volatility.

If the user seeks to reduce the likelihood of inconsistent losses (IMPERMANENT LOSS, IL), he should choose the most wide section of the price curve.

Each Uniswap V3 liquidity manager has its own approach to choosing a range and position management. These services provide for a certain reward for the result (Performance Fee), the source of which is the Uniswap V3 commission. The received remuneration is used to cover gas expenses during rebalance, redemption of control tokens and other purposes.

To show the importance of taking into account such commissions when choosing liquidity management strategies, Vividot cited the following example:

“Suppose manager 1 uses a wide range strategy (low LP commission, a little probability of IL). Manager 2 uses narrow ranges (high LP commission, high probability il). In this case, the remuneration for the result is the same (10%), as well as the result itself in the form of LP commissions and the value of IL. However, manager 2 will pay more commissions for rebalance, which is undesirable from the user’s position “.

According to the expert, the period of rebalance is also very important, since the compound of the LP commissions and the implementation of losses due to IL depend on it.

Review of Uniswap V3 liquidity

Alpha vault. This is the first service of this kind, launched on May 7 – two days after the start of the third version of Uniswap. At the time of writing (10.08.2021) Three automated liquidity pool operates:

• WBTC/USDC;
• ETH/USDC;
• ETH/USDT.

The cost of funds (TVL) of the first pool exceeded $ 2.6 million, the second and third – $ 1.2 million. The project periodically increases limits on the total amount of funds in storage facilities (Vaults).

Alpha Vault uses the passive method of rebalance and ranges depending on the weight average of the price (TWAP). The remuneration for the result is 5%, funds go to the Chambers’ Treasury.

The chart below shows the dynamics of the Weth/USDT pair. Svetly blue and blue colors are highlighted by rebalant and basic orders.

As you can see, the ranges are quite wide. This approach is designed to reduce the amount of losses with sharp price movements.

Gelato Network. The project has its own ERC-20 standard token-G-UNI. It is used in the liquidity mining program created with the assistance of the Defi-platform of the InstadApp.

Liquidity management takes place on the Sorbet Finance service from GELATO NETWORK developers.

The platform is positioned as a network of bots using smart contracts for active rebalance. The price range is determined by the developer team. The remuneration for the result is 10%.

Visor Finance. Beta version of the service began work on May 18. The project uses lanes of the Bolinger to determine the price ranges.

The graph shows that the project involves narrower ranges of the price curve. This is probably done to maximize income during periods of a relatively calm market situation.

The passive method of rebalance is used. The remuneration for the result is 10% (funds are used to redeem VISR tokens and consumer remuneration).

Aloe Capital It is positioned as an autonomous liquidity distribution protocol for Uniswap V3. The main idea of ​​the project is to use prediction markets to select a rebalance ranges.

“Aloe helps passive liquidity providers receive advantages of concentrated liquidity, as well as rewards steatherrs for their predictions,” the service website says.

Project tokens stakers can offer ranges in which, in their opinion, the price will remain in the next hour. The protocol rewards the market participants for accurate forecasts and subjects the rags for incorrect predictions.

Rebalance method: passive. The total supply of tokens is fixed – 1,000,000 ALOE, 5% of which is provided as a reward to steakers for forecasts.

Lixir finance. According to the description, the project provides optimal capital efficiency with minimal inconsistent losses.

“Just choose the desired couple of tokens and Lixir optimizes and automatically balances your position accordingly,” the service website says.

In addition to LP commissions, users can receive LIX tokens in the process of liquidity mining.

If the current price range changes significantly, the developers create a repository with other parameters.

The project was an audit with the participation of Least Authority, Haechi, Peckshield and Certik.

Underwater rocks

Created by Vividot Dashboard on the Dune Analytics service monitors not only the dynamics of liquidity managers, but also the profitability of these tools.

The schedule below shows the performance indicators of the WetH-Usdt pool under the control of the Alpha Vault service (blue line; IL and LP commission are taken into account) in comparison with the simple storage of Ethereum in the wallet (red line) and a similar pool of the second version of Uniswap (green line; not taken into account commissions; , but only il).

As you can see, the liquidity manager is much lower in comparison with alternatives against the backdrop of confident increase in Ethereum in early August. On the other hand, during the July correction of the market, the WetH-Usdt position on Alpha Vault was not so deep in comparison with the price of ETH, but approximately comparable to the indicators of a similar pool on Uniswap V3. Obviously, in both cases, stablecoin from Tether reduces the volatility of the position.

Similar indicators in a similar pool running Visor Finance, where Bolinger’s stripes are used.

WetH-Usdt indicators are even stronger than alternatives against the backdrop of the price of Ethereum prices. The advantage can be considered a shallow drawdown of LP positions against the background of the July correction of the market.

The profitability of the Sorbetto Fragola product from Popsicle Finance does not encourage.

Judging by the schedules, the old-like pools of the second version of Uniswap show themselves better than the V3-optimizers. During periods of the bull market, it is easier and more profitable for investors to store assets in the wallet (hodl).

“Now the LP has good indicators that are not going beyond the wide price range,” said Vividot. – If the price of ETH is very falling or growing, going beyond the range, the indicators can be terrible. “.

The Twitter user under the nickname Revert gave an example of the indicators of the ETH/USDC position in a wide range-$ 1665- $ 3334.

1/ ETH/ USDC Position on a Range from $ 1655 – $ 3334 HAS A 94% Apr VS Hodl. IT Has Stayed Within Range 100% of the Time for Its 42 Day Life, Has Had No Capital Reallocation Or Fee Collection. https: // t.CO/2ZK2BOVGO1 https: // t.Co/Ta111Taiyaz Pic.Twitter.COM/86her3UFPS

– Revert 🦇🔊 (@revertfinance) July 3, 2021

According to his observations, the position demonstrated profitability, almost comparable with Hodl. Throughout 42 days of observation, the position remained within the established range.

Like any other Defi services, concentrated liquidity managers are not safe from hacks and bugs. The aforementioned Popsicle Finance protocol has recently been attacked, as a result of which he lost $ 20.7 million.

The error was found in the product of the Sorbetto Fragola project. The attacker devastated 85% of bullets.

“The hacker forced the contract to believe that he received as many commissions as the total amount of funds blocked in the pool and, based on this, has the right to $ 20.7 million in the pool,” the project said in the message of the project.

Subsequently, he exchanged the received coins for ETH on Uniswap, and then sent funds to the Tornado mixing service.Cash to wash.

Representatives of Popsicle Finance later reported that 439 addresses were injured from the attack. 146 of them had active positions at least in one pool. In 62% of addresses, the cost of losses was less than $ 10,000, in 86% did not exceed $ 60,000.

The developers assured users that the bug was found, as well as developed plans to compensate for funds and restarting Sorbetto Fragola.

conclusions

The profitability of most LP-optimizers is not yet impressive. It is much lower in comparison with the usual Hodl’s and Uniswap V2 liquidity bullet indicators. On the other hand, this subsection is only born and it is too early to draw strict conclusions about the effectiveness of such services.

The most interesting is the approach of Aloe Capital, which consists in integration with the markets of predictions. However, it is quite problematic to predict the future prices of volatile crypto assets, so the tokenomics of the project has yet to prove its effectiveness.

UNISWAP V3 potential is far from exhausted. The concept of concentrated liquidity opens up wide opportunities for creating automated asset management strategies. The success of the developers of new solutions will expand the capabilities of crypto -investors, democratize market makeup in Defi and strengthen the market position of Uniswap in conditions of tight competition.