📉Principal Loss
General strategies to think about LP losses and mitigate them.
Last updated
General strategies to think about LP losses and mitigate them.
Last updated
The singular risk of liquidity providing is lost upside. An LP position essentially trades away the token upside in return for market making yield. Thus LPing is most suitable when token prices remain stagnant for long periods of time.
There are lots of proposed methodologies for how to measure Liquidity Provisioning PnL. Some use Impermanent loss to measure the opportunity cost, some use Loss Vs. Rebalancing, but here at Itos we prefer the simple approach of just measuring the change in US dollar value. At the end of the day, everyone's got to eat and we can't feed myself on Rebalancing comparisons; we need real value appreciation.
While we recognize that a huge portion of DeFi users (maybe even a majority) are international, there is simply the most oracle/infrastructure support for USD, the most liquidity for USD-pegged assets, and it's easily understood by all audiences. Therefore for safety and UI reasons, we measure all PnL in the change in USD value.
There are lots of different strategies for mitigating potential LP losses. We make the opinionated choice of emphasizing gamma hedging through Takers, but you're welcome to use other methods as well.
We specifically designed Itos accounting around gamma instruments which have a non-linear relationship with price; in particular Automated Market Taking based hedging. Using Takers allows users to open the hedge once and never touch it again. Takers can also perfectly hedge any type of position to a guaranteed floor value (sans the Taker fees of course). Their price action is also localized meaning they won't cancel out your profits like other forms of hedging. And finally, we make them relatively easy to use.
Gamma hedging requires close to no management, is easy to use and understand on Itos, and has minimal side effects which is why we believe it's the most suitable for most users.
The IL-Hedged and Real-Hedged LPs are specific forms of Gamma Hedging an LP position.
Delta hedging means buying/shorting tokens/perps to net out any unwanted exposure. LPing has greater loss-exposure when the price moves down so often people use delta hedging to adjust that exposure to make a "delta-neutral" position which just balances losses between the upside and downside.
Options underwriters use delta hedging to sell options at no principal risk to themselves. They constantly buy and sell the underlying so that when combined with the sold option, their net exposure is zero.
Delta hedging is most useful when transaction costs are cheap and gamma hedges are too expensive. This is because proper delta hedging requires a lot of active management. Hedges need to be rebalanced on price changes, but rebalancing too frequently will incur significant transaction costs and rebalancing too infrequently exposes your position to unwanted risks.
Therefore outside of making slight adjustments to your Liquidity position's overall delta exposure, we don't have UI supporting delta hedges. But the Itos platform is flexible enough that users can do it themselves if they so choose.
Lots of AMM purport smarter market making curves to help mitigate losses. In reality, they're moving the risks from one location to another. Take for example the stable coin swap. It reduces the swap price impact around the price of 1, but once the token pair is knocked off its peg the risks dramatically increase. So in general there is no "one curve" that is better than all others. In fact, mathematically, constant product curves can be transformed into any other curve simply by depositing assets into targeted price ranges. This is why we focus on a concentrated constant product AMM. In the future we may introduce new curves but it is not a priority at the moment.
Using alternative market making curves to mitigate losses is a very reasonable strategy as long as you recognize where the losses have been moved to. Depending on that, some curves may require more active management than others.
