Protecting Your Assets in AMM Pools in This Choppy Market
In this article, we will answer some of the most frequently asked questions about our IL protection product and introduce a more cost-effective variant — “limited IL protection”.
Since we published the article “The Ultimate Solution to Overcome Impermanent Loss”, we have received an overwhelming response. The topic became even more relevant after the turmoil last week. Many suffered heavy losses from the market crash, which was a stark reminder of the importance of disciplined risk management.
To recap our previous article, we offer an IL protection product that compensates liquidity providers for the IL they suffer. By paying a fixed premium, liquidity providers effectively transfer the entire IL risk to us and do not need to worry about it anymore.
Here are some of the most frequently asked questions about our IL protection product:
Does it work with Uniswap V3?
Yes, it works with V2 and any bespoke range under V3.
How much does it cost?
The table below shows indicative premiums of ETH-USD protection for various durations and price ranges.
How are premiums determined?
Premiums mainly depend on 2 factors:
- Volatility of the underlying token pair — the higher the volatility, the more expensive the premium.
- Duration of the protection — the longer the duration, the more expensive the premium.
Can you offer protection on altcoins?
Yes, we can offer in the top 10 cryptocurrencies. For the rest, we can vet on a case-by-case basis.
Can you protect the USD value of my LP positions?
Yes, we can. You just need to be aware that the payoff formula is different from the conventional IL which is benchmarked against the HODL value.
What details will be specified in a contract?
Typically, a contract will contain the details below:
- Token pair
- Total notional to be protected
- Duration of protection
- IL formula
- Initial price
- Premium
- Lower/upper bounds (for Uniswap V3)
What if I no longer need the protection?
This may happen when the spot has moved away from the initial level and liquidity providers wish to withdraw liquidity or reset the range (for Uniswap V3). In this case, liquidity providers can sell the protection back to us and they can subsequently re-enter a new protection for the new range.
How does OrBit manage the risks?
As a group of experienced derivatives traders, we manage the product as an exotic option. Using our advanced quant models and risk engines, we construct and dynamically rebalance an optimized portfolio of futures and vanilla options to neutralize the risks of IL. While some LPs may already be doing something similar by themselves, OrBit can do it more quantitatively, accurately and efficiently.
Limited IL Protection
The defining feature of Uniswap V3 is concentrated liquidity which significantly improves capital efficiency. However, the potential for greater returns comes with greater risks too. The tighter the price range, the steeper the impermanent losses, as illustrated in the diagram below.
Unsurprisingly, premiums for tighter ranges are higher. As shown in the table above, the 30-days [80%-120%] range costs 6.76%, vs 4.21% for the [50%-150%] range, and 1.16% for V2.
IL calculated this way has an implicit assumption that liquidity providers sit on their hands and let the positions run even if the spot has gone outside the range. In practice, this assumption is rarely true. Liquidity providers usually monitor the range closely and will likely exit the pool or redeploy liquidity in a new range once the old one is breached. The actual IL incurred is likely to be capped at the upper and lower bounds, as illustrated in the chart below. We call this modified payoff “limited IL protection”.
With insured losses being capped, premiums are cheaper too:
- If the price has exceeded either the lower or the upper bound, the product pays the IL and terminates immediately.
- If the price has stayed within the range until maturity, the product pays the IL and expires.
Such a product is better aligned with the way liquidity providers manage their positions and it’s more cost-effective. The table below shows indicative premiums of ETH-USD limited IL protection for various durations and price ranges. The 30-days [80%-120%] range now costs 4.10%, vs 6.76% for regular IL (in the table above), a 40% cheapening.
About OrBit
OrBit Markets is an institutional liquidity provider of exotic options and structured products in digital assets. Founded by a strong team of leaders in trading and computer science, and backed by Matrixport and Brevan Howard Digital, OrBit brings its expert know-how in options to the crypto market. Headquartered in Singapore, OrBit serves institutions across CeFi, DeFi and TradFi looking for more sophisticated investing and hedging solutions in digital assets. For more information, visit www.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.
