How to Hedge Impermanent Loss with Options
Dear friends.
Our team is actively working on the development of Alcor Finance. We are doing everything possible to launch on the mainnet as soon as possible and enable you to trade on-chain options on the mainnet.
In the meantime, we want to explain you how options can be used to hedge liquidity providers’ Uniswap V3 positions.
Let’s say a liquidity provider opened a position on the USDC-ETH pair.
Liquidity providers set the desired price range in which their provided tokens will be used and receive swap fees. The narrower the range, the more fees it will earn on each swap. With a narrow range, the price will exit it faster, and the position will no longer earn commissions.
Let’s consider how the total portfolio value of a position of a liquidity provider depends on the price of ether.
for a more detailed explanation of why such a graph is obtained, read the link: https://medium.com/@kirill.bogomolov95/uniswap-v2-v3-impermanent-loss-e6b47183033a
What is the problem with this position?
The problem is that if the price goes down, then the liquidity provider will take more and more losses. At first, due to the curvature of the Uniswap V3 position (as long as the price is in the range), the loss will not be that big, but as the price moves down, the loss will increase more and more.
This means that the liquidity provider has an open risk on the price of the underlying asset.
What can a liquidity provider do?
The liquidity provider can buy the option, then the position will not be so dependent on the price of the underlying asset.
Thus, if a liquidity provider opens a Uniswap V3 position and then buys a put option, then its total risk profile will look like this:
Ultimately, the liquidity provider has a lot less risk while still earning fees by providing liquidity in Uniswap V3.
Therefore, options in the near future will be one of the key tools for risk management in the DeFi space.
If you have any questions, our team is in Telegram and ready to help.
Stay tuned. It’s just the beginning!
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