What are Yel Finance Potions?
Yel.finance has made a volatility mining tool. What is it?
What is volatility in crypto?
Volatility is how fast a price changes. When Bitcoin loses or gains 8% in a single day, we say there has been a lot of volatility. Smaller tokens can have much more volatility, sometimes even greater than 20% per day.
How are tokens bought or sold on DeFi?
I already wrote an article about how LP works, and this is necessary to understand Potions. If you are not familiar with how LP works, please read it here: LP Impermanent Loss is a Misunderstood Problem You Would Like to Have.
What is arbitrage in crypto?
Take this example: we use a time machine to bring an ETH/USDC Liquidity Pool (LP) from the past to the present. At the time, ETH was worth $1,000, so in this LP, there was 100,000 USDC and 100 ETH. Hence, the price for a single ETH is 1,000 USDC, or $1,000 as we said.
But now, in the present, a single ETH is worth more than $3,000 or 3,000 USDC, not 1,000! The point is that an LP is a smart contract and it will not get price updates magically. Any v2 LP with 100,000 USDC and 100 ETH will give you 1 ETH if you send it 1,000 USDC, regardless of the current market price.
You might say: “That’s impossible! All the prices are updated everywhere! If I buy ETH from Uniswap or Sushi or whatever DEX, I always pay the same price!” You think this because you almost always are late, but every LP is a standalone entity.
Continuing with the example: if we place that LP in the present, you could exploit it by swapping 1,000 USDC for 1 ETH, then going to another updated LP (like Uniswap) and swapping your new 1 ETH for 3,000 USDC. You could then return to our original LP and swap 3,000 USDC for… 3 ETH?
No. Each time you swap, the price for the next swap changes. So this time, you will get 1 ETH not for 1,000 USDC but for, say, 1,250 USDC. It’s still profitable since the market price is $3,000, so you continue to swap and sell more and more until you bring the LP price in line with the market.
If you do this, you are performing arbitrage between LPs. This is exactly how prices are kept more or less the same across different LPs for the same token.
Can we profit from this?
We can profit from this, but like everything in life, we can profit only if we create profit for others too. Until now, DEXs were made trader-oriented, not arbitrageur-oriented. This means there was a race to create the cheapest DEX (usually with swap fees ranging from 0.3% to 0.01%), and arbitrageurs would just use whatever DEX they found out of sync to extract a profit.
Potions is a DEX built for arbitrageurs, not for traders. LPs in this DEX have a (relatively) high fee to swap, so it is not expected to be used for usual day-to-day trading. However, it creates more APR for liquidity providers when a swap is made.
Let’s make another example, not 1:1 perfect but to understand: If we have an ETH/USDC LP with a 1% swap fee, normal traders will not swap here since it’s cheaper to swap on Uniswap with a 0.3% fee. Since normal traders will not use this LP, it will often be out of sync with the market price. Every time the difference from the market price is greater than the swap fee, there will be an arbitrageur who will use our LP to take a profit.
It is as simple as that conceptually: we make arbitrageurs pay to swap on an LP that is often out of sync (which is what they are looking for), and we get paid more fees for every swap (which is what we are looking for).
More about Potion strategies here.
Is it really so simple to create a new product?
Of course it is not. All this will not work if we have no liquidity in the LPs, so we need to create incentives for money to be deposited in our LPs instead of trader-oriented LPs. There are three incentives on Potions, one temporary and two permanent.
First incentive: Chain token airdrops (temporary)
For a limited time, new L2 chains will give tokens to projects to help bootstrap liquidity: $OP on Optimism, $ARB on Arbitrum, $BLAST on Blast, and so on. Depositing on Potions will farm these chain tokens. Currently, they are on Blast, farming Blast Points and Blast Gold.
Second incentive: Higher fees proportional to volatility
As the title says, providing liquidity on Potions will earn a bigger swap fee than other LPs. Whether this higher fee translates to a higher APR depends on market volatility. There will be market conditions where a traditional LP earns more APR, but there will be others where a Potions LP earns more. It is a tool for diversifying investments for those wishing to deposit liquidity on LP.
Third incentive: Liquidity tokens (lTOKENS)
Potions LPs are not created directly with the assets. For example, a WETH LP does not have WETH paired with USDC but has lWETH paired with USDC (lWETH/USDC LP). They work similarly to how a TOKEN/xTOKEN mechanism works: for every lTOKEN, there are a number of TOKENS, and this proportion will grow over time. Every time a TOKEN is wrapped into an lTOKEN, a 1.5% fee is taken. Similarly, every time an lTOKEN is unwrapped to TOKENS, another 0.9% fee is taken. These fees are distributed to lTOKEN holders, providing yield to the lTOKEN.
For example, a Potions LP for ETH will have an lETH/USDC pair. If ETH gains 10%, the lETH price will be 10% less than the market price, so arbitrageurs will swap USDC for lETH (at a 10% discount, paying a 1.5% fee), unwrap lWETH to WETH (paying a 0.9% fee), swap WETH to USDC, and end up with more USDC than they started with, even after paying all the fees.
This mechanism also incentivizes keeping the liquidity staked for long periods, ensuring some stability in the liquidity.
And what about YEL token?
I will write a different article about the YEL token.
For the time being, just know we burned 1/3 of the supply, reducing it from 400,000,000 to 280,000,000. There will be no more emissions, and all the yield it generates comes from buybacks funded by fees.
Potions is the first product that actively generates fees, and these fees are paid to lYEL, making lYEL not only a liquidity token but also the place to stake YEL to capture protocol fees.
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