USDC.e — WXT Nereus’s Native Liquidity Pool

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Nereus-protocol

5 min readFeb 11, 2022

The native liquidity pool of a DeFi protocol like Nereus is the fundamental element of the protocol’s ecosystem which increases the liquidity of the market for the protocol’s native token. The existence of a Liquidity pool should significantly enhance the participant’s experience within a protocol, allowing them to exchange their tokens at a fair market price with reduced slippage, provided sufficient capital is present within the LP. Additionally, Liquidity Pools allow their contributors to earn rewards in the protocol’s native token by staking their LP tokens and receive their proportional share of the fees generated within the LP. The initial rewards distribution to liquidity providers should be substantial enough to attract liquidity. In addition, the LP mechanics, including the fees distribution, should be conceived such that the protocol keeps reasonable control of its native tokens circulating supply.

Fundamentals of Liquidity Pools

DeFi Liquidity pools were initially designed and implemented by the Bancor protocol. Bancor designed its liquidity pools to replicate market makers behaviour and boost the liquidity of thinly traded decentralised markets: hence the designation Automated Market Maker (AMM). AMMs hold two different token reserves on smart contract-owned addresses with a converter contract enabling traders to swap one token for the other. The process consists of depositing the tokens sold in the corresponding reserve and retrieving an amount of tokens from the other reserve. The quantities are determined by a simple formula (e.g., a bonding curve for Bancor, or a constant product formula for Uniswap). This process resolves the liquidity issues within thinly traded markets, as it does not rely on matching buyers and sellers to trade, as the pooled assets should always be available to be traded against, provided sufficient capital is present within the LP. Applying economic theory, the addition of an LP to a Tokens ecosystem should increase its fundamental value, as it decreases the pair’s liquidity premium.

The addition of the USDC.e — WXT LP to the Nereus protocols ecosystem should enable protocol participants to easily exchange large volumes of WXT for USDC.e or USDC.e for WXT, without experiencing significant losses due to slippage. The USDC.e — WXT Trader Joe’s AMM will be originated with a 50/50 ratio, this mechanism prioritises providing liquidity to the WXT token market, in keeping with the battle-tested LP mechanisms standardised by DeFi protocol Uniswap.

Nereus will also follow the market norm with respect to incentives and fees:

Liquidity providers who stake their USDC.e-WXT LP tokens within the Nereus protocol have been allocated 212.5 million WXT tokens, which will be distributed over 4 years following the Nereus reward distribution schedule.
Additionally, USDC.e-WXT LP participants will receive their proportional share of the 0.25% fee charged on all trades within the liquidity pool.

Impermanent Loss

Liquidity providers are exposed to the risk of impermanent loss. Impermanent loss is caused by a unidirectional price movement, and it is exacerbated by market volatility. To understand the risk of impermanent loss, we can consider the scenario where traders can swap without fees, and where demand for WXT soars, resulting in a severe depletion of the WXT reserve (due to arbitrage traders). In this case, if a liquidity provider were to exit the pool, she would mostly retrieve USDCs from the LP as she can only redeem her proportional share of the pools tokens she deposited. In this case, she will collect less of the significantly appreciated token than deposited, meaning a HODL strategy would have been more economically viable than depositing within the LP.

Faced with the risk of impermanent loss, the market maker has usually two options:

Hope for the market price to revert to her initial entry price, or for the fees to cover the impermanent loss eventually.
Hedge her inventory exposure through derivative instruments (futures or options) to manage her losses. Hedging here consists of buying high and selling low: it is reminiscent of the ‘short gamma’ strategy where time value (‘theta’) corresponds to the fees earned.

Impermanent loss is a risk inherent to all liquidity pool products, although the WXT rewards available for LP stakers within the Nereus protocol, paired with LP participants receiving their proportional share of the 0.25% fee charged on all LP trades should ensure that all liquidity providers will be adequately compensated for Impermanent loss risk.

The graphic above shows the percentage impermanent loss that will be incurred when the USDC.e & WXT tokens change price (based upon the price of these tokens on 04/02/2022). The percentage loss an individual investor will incur will vary based upon the market price of the WXT & USDC.e on the day they deposit & withdraw from the LP. The above graphic does not account for LP staking fees or % fees received by LP participants.

Nereus USDC.e — WXT LP Staking

As previously mentioned, USDC.e — WXT Liquidity providers will be able to stake their LP tokens within Nereus in return for WXT rewards. This feature will be available on the third week of the Nereus protocol and has been calibrated to ensure LP token stakers will receive over 100% APR in WXT rewards over the first 10 weeks of the Protocol. This high APR should work to incentivise community members to become Liquidity providers and initiate the building of our self-sufficient Nereus Protocol ecosystem.