Synthetic Uniswap LP via Options
Ever wondered if you are rewarded enough fees for providing liquidity on Uniswap? In this article, we present OrBit’s Synthetic Uniswap LP product which enables you to earn higher fees than actually providing liquidity on Uniswap, without increasing your risks.
The economics of providing liquidity in AMM protocols like Uniswap are simple: receiving fees for taking the risk of impermanent losses (IL). The strategy is profitable as long as fees can more than cover the losses.
Fees are affected by trading volumes and TVL which are unknown a priori. On the other hand, IL depends on volatility and price swings which can pose significant risks. Both fees and IL are moving numbers, making it difficult for liquidity providers (LPs) to predict profitability.
Guillaume Lambert wrote an excellent article “On-chain Volatility and Uniswap v3”, in which he proposed a way to estimate Uniswap implied volatility. The Uniswap implied volatility of ETH-USD is currently between 44% and 49% (see screenshot below) whereas liquid option markets price it much higher at 75%~80%.
This suggests that LPing on Uniswap has 2 major drawbacks:
(1) Unknown fees — Fees you earn depends on the trading volume and locked liquidity, hence there is no way to accurately predict fees in advance;
(2) Low fees — Uniswap’s implied volatility is significantly lower than where it trades in the options market, you are simply not earning enough fees.
OrBit’s Synthetic Uniswap LP product provides a unique and innovative solution to tackle these 2 problems. Here is how it works:
Liquidity providers pre-agree on a fee level with OrBit and stake liquidity with OrBit instead of in an AMM pool. At maturity, OrBit returns the liquidity to LPs, plus the pre-agreed fee, and minus any IL incurred based on the IL formula.
Let’s look at a concrete example. A liquidity provider plans to provide liquidity in Uniswap V3 ETH-USD pool over the price range [1600, 2400] for 30 days with 1 million USD. Instead of actually injecting capital in Uniswap, she could stake the capital with us, and earn a guaranteed fee of 4.95% (APY 80%), minus any impermanent loss incurred after 30 days. If the spot fell from 2000 to 1800, the IL would be 1.37%, net she would receive 4.95% — 1.37% = 3.58% over 30 days, or an APY of 53%.
The benefits of such a fee protection product are obvious:
- Fee income is known in advance, unaffected by adverse changes in the trading volume and locked liquidity.
- Same risk exposure as providing liquidity on Uniswap.
- Potentially higher yields than actually providing liquidity on Uniswap.
The table below shows the guaranteed fees on ETH-USD for various durations and price ranges (priced as of 24 May 2022). If a LP estimated that it would be difficult to generate more fees than indicated in the table, then she would be better off investing in our Synthetic Uniswap LP product which effectively benefits from the higher implied volatility available in CeFi options market.
What does OrBit do behind the scenes?
As a group of experienced derivatives traders, we use our advanced quant models and risk engines to synthetically replicate the Uniswap exposure via a carefully calibrated portfolio of vanilla options, which is then dynamically rebalanced to maintain the pre-agreed fee target. By selling volatility via vanilla options which are priced at much higher implied volatility than Uniswap LP, OrBit is able to offer higher fees.
About OrBit
OrBit Markets is the leading institutional liquidity provider of digital asset options and structured derivatives. Founded by a team of former executives in finance and technology, OrBit combines its expert know-how in financial derivatives with the latest blockchain technology. With a mission to develop innovative investment and hedging solutions for digital assets, OrBit Markets offers a wide range of products, including vanilla options, exotic options, and structured derivatives across major and alternative cryptocurrencies. Its services encompass structuring, trading, and market making. For more information, visit orbitmarkets.io.
Important Disclaimer
This article is intended for educational purposes only and does not constitute the provision of investment advice and is not intended to do so. OrBit specifically disclaims all liability for any direct, indirect, consequential or other losses or damages that may arise from any reliance on this article.
Trading in cryptocurrencies, derivatives and structured products may involve a high degree of risk and may not be appropriate for all investors. Under some market conditions, it may be impossible to liquidate a position. Investors may suffer substantial losses and even lose the entire amount of your investment.
The product described in this article is intended for sophisticated investors capable of evaluating the merits and risks of the product, its suitability and appropriateness and its legal, taxation, accounting and financial implications.
Prices provided in this article are illustrative only and do not represent a firm bid or offer price.
