Hey everyone, today I would like to tell you about the DLP that the decentralized exchange Drift has introduced to us, and most importantly, this move is innovative in the world of DeFi.
Before we start, let’s dig into the basics and understand what market making(MM) is.
In the market there are often situations when demand exceeds supply, and thus there is destabilization of quotations, where the price of an asset undergoes large changes. To prevent such situations there is a special class of market participants — market makers, who by their activity support prices for financial assets.
There are many market makers who conclude contracts with exchanges, projects, etc. in order to fulfill their main function — maintaining stability.
In the case when a massive sale of an asset starts and there is pressure on the price, the market maker in this case is the flip side of this “movement” where he buys back these assets to balance supply and demand.
With the advent of DeFi and many different DEXs, an innovative idea emerged — Automated Market Maker(AMM), and the main innovation is:
- A mathematical algorithm.
- Liquidity pool.
If the traditional variant uses a stock exchange orderbook, in this case, pricing is done through a mathematical formula. When you want to sell or buy an asset, funds are sent to the appropriate pool, and the algorithm calculates the price based on the number of tokens in it.
The ultimate goal of the formula is to determine a stable price for each asset in the liquidity pool. It is achieved by decreasing the value of one asset and increasing the value of another to ensure equilibrium.
Note: there is a lot of material detailing this topic with examples, so if you want to go deeper into this issue, Google is always open for you =)
DEXs allow absolutely every user to add their funds to a liquidity pool in the form of a pair of tokens and receive a percentage of commissions for transactions made on that pair.
What is DLP?
Drift Liquidity Provider(DLP) is the same opportunity for users to become liquidity providers, which has some differences that I want to write to you about.
DLP has a democratic character, where each user, being a liquidity provider on Drift, is essentially a market maker, as DLP functions as a counterparty against Drift traders through the vAMM (Virtual Automated Market Maker) mechanism.
The liquidity presented gets denoted as DLP shares, similar to the collateral used by open, unfilled orders.
Also worth noting, vAMM removes the need for LPs to manually manage their positions as they automatically take opposite positions from new trades made against vAMM. There is a risk to consider here (more on this below).
Let’s look briefly at an example:
“if LP contributes 10% of vAMM liquidity in a SOL/PERP pair and a trader opens a long position for 10 SOL, then by the logic of the mechanism LP opens a short position for 1 SOL in addition to the corresponding trading commissions”
DLP opens up flexibility for users who want to provide liquidity:
- Provide liquidity to individual trading pair.
- Select the desired leverage (up to 10x).
When liquidity is provided users receive:
- 80% of commissions collected by vAMM, which are allocated based on liquidity share.
- LPs also receive funding and any P&L from settled positions.
Given that revenues are shown in the unsettled/settled P&L the team recommends that users create sub-accounts for DLP to separately track your DLP.
What are the Risks?
Before starting to use DLP I strongly recommend to study all the existing risks, so that the user understands the detailed design of this product and realizes all the existing risks.
It is important to note the most important risk — liquidation. Given the vAMM operation, your positions will be opened automatically depending on the market situation (traders’ actions). DLP positions need to be actively managed as they can accumulate over time.
Also, different market situations may change the leverage set, which also indicates that DLP is not a standard liquidity provision scheme. This new mechanism requires you to be “present”, especially if you use leveraged DLP.
There are no guarantees that positions taken on by LPs won’t lead to losses.
For a more detailed breakdown, I’ll leave you with some links to explore DLP on your own:
You can also join the Discord of the project to ask there any question you are interested in.
I leave all project links in the description below!
Website | DEX Website | Discord | Twitter | Medium | Blog | Documentation | Github
