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An In-depth Guide to Thorchain’s Liquidity Pools

Understand how to use liquidity pools to earn greater, more stable and or less risky yields.

This article is written by @Bitcoin_Sage. He shares valuable insights and information regarding Thorchain on a daily basis with his followers on Twitter. If you enjoy this article or are interested in Thorchain, consider following him.

In the first article of this series you read about the basics of liquidity pools and how to interact with them. In this article we’ll explore them further. I’ll explain the following topics:

  • Adding funds asymmetrically to liquidity pools.
  • How to identify the most profitable liquidity pools.
  • Examples of how liquidity pools perform in different market conditions.
  • Different strategies to earn greater, more stable and or less risky yields.
  • How to track your returns

Adding Funds Asymmetrically to Liquidity Pools

There are two ways to add funds to a pool. Currently the interface of choice is BEPSwap. Let’s take the RUNE:BNB pool as an example. You can add funds symmetrically by selecting the ‘ADD BNB + RUNE’ tab. This adds both assets to the pool in equal proportion, 50:50.

The second method to add funds is asymmetrically. A lot of people are holding assets because they do not want to unnecessarily trigger taxable event. The assets can appreciate in value but do not bring any additional income on top of that (rewards or share on fees). Providing liquidity on Thorchain asymmetrically doesn’t trigger a taxable event, since you do not swap assets before adding them to the pool.

If you aren’t holding two assets you are bullish on, but just one, you can provide liquidity asymmetrically. Thorchain doesn’t change the composition of what you add. It’s only changed when you withdraw. Thus it’s only a taxable event once you withdraw your funds out of the liquidity pool.

You do this by selecting the ‘ADD BNB’ tab. This adds only BNB to the pool. The pool will automatically swap 50% of the BNB you add, for RUNE. Be careful that you don’t bring the pool out of balance by adding a lot of funds relative to the pool’s depth, as it would shift the pool price. It will result in arbitrageurs correcting the pool and you loosing some value.

With both methods you’ll end up with the same share of the pool.

Basics of interacting with BEPSwap explained

How to Identify the Most Profitable Liquidity Pools

  • Ownership %, the amount of funds added to the pool
  • Volume of swaps
  • % Slippage swappers are willing to take
  • Rate of change of RUNE vs ASSET
  • Incentive pendulum

Ownership %

If a user added assets with a value of $1.000 to a pool with a total value of $10.000, the user now owns 10% of that pool. Meaning the user now receives 10% of the rewards the pool generates. When more liquidity gets added to the pool, the ownership % of the user drop.

Volume of Swaps

Every swap requires a network fee + 1 RUNE. This 1 RUNE goes directly to liquidity providers. More swaps made in a pool, translates directly to more fees for its liquidity providers.

Slippage

Swappers pay two fees during each swap, the above mentioned network fee and a slippage fee. The slippage fee is based on the size of the swap relative to the depth of the pool. A big swap in an illiquid pool could easily incur 10% slippage.

A proportion of each slip is kept in the pool. This is allocated to liquidity providers and forms part of their yield.

To calculate slippage I prefer to use Delphi’s slippage calculator.

https://defi.delphidigital.io/thorchain/chaosnet/

Rate of Change of RUNE vs ASSET

If the price of the assets change, liquidity providers will receive more of one and less of the other asset. This might change the yield if it’s being priced in a third asset, eg. USD.

Incentive Pendulum

The incentive pendulum is an integral part of Thorchain’s system. It incentivizes users to keep the network secure and stable. It does this by incentivizing nodes/liquidity providers, depending on the state of the network. In a future article I’ll discuss the incentive pendulum in detail.

See the Delphi Digital dashboard for the actual state of the incentive pendulum. It also shows, the % of earnings generated by the network liquidity providers receive.

The Incentive Pendulum

Tools

Now that we know which factors affect yield, let’s take a look at two important tools which will help us identify the most profitable pools. Delphi Digital’s dashboard and runedata.info.

https://defi.delphidigital.io/thorchain/chaosnet/

Delphi’s dashboard is still in development and more features will be implemented. In its current form it’s still valuable for liquidity providers. By sorting the pools on mean fee, you can see which pools receive the highest slippage fee %.

A pool with a high mean slippage fee and a high relative volume is likely to be profitable. In the screenshot above one pool stands out to me, the BULL pool, which is a 3x long Bitcoin token. The FRM, ETHBULL and SWINGBY pools also look interesting.

On runedata.info we can verify our previous observations. By comparing the fee accrual from the different pools over the past weeks/months. Below you can see the BTCBULL pool increased its liquidity providers’ assets by ~19%. This is a 87% APY (excluding potential impermanent loss).

BTCBULL pool’s performance since NOV 1st.

The Performance of Liquidity Pools in Varying Market Conditions

Liquidity pools are always kept in balance by arbitrageurs. They keep the ratio of assets in the pool 50:50. If Rune increases in value, the pool’s price increases as well. Making it lucrative for arbitrageurs to swap Rune out of the pool and sell it on secondary markets, until the price on Thorchain equals the price on secondary markets.

The same goes when the paired asset increases in value on secondary markets, arbitrageurs swap the paired asset out since it’s currently undervalued on Thorchain.

Arbitrage is what’s generating most earnings for Thorchain’s liquidity providers and node operators. Volatility is great for Thorchain’s yield.

Example #1: Rune Increases vs Asset

We are a liquidity provider in the RUNE : BTC pool. Over the past week RUNE’s price increased significantly. Making arbitrageurs swap RUNE out of the pool and sell it on secondary markets.

A liquidity provider will see this reflected in his ‘pool shares’. The amount of RUNE has decreased and the amount of BTC has increased vs the start of this week.

Example #2: Rune Decreases vs Asset

We are a liquidity provider in the RUNE : ETH pool. Over the past week ETH’s price doubled. Making arbitrageurs swap ETH out of the pool and sell it on secondary markets for a profit.

A liquidity provider will see this reflected in his ‘pool shares’. The amount of RUNE has increased and the amount of ETH has decreased vs the start of this week.

Example #3: Rune vs Asset Stable

If the price of RUNE diverges minimally from the paired asset, arbitrageurs don’t have a reason to swap. As arbs are responsible for the majority of fees generated, the pool will have minimal returns.

Strategies

Liquidity providers can deploy a multitude of strategies. We’ll focus on 3 aspects:

  • Maximum Yield
  • Stable Yield
  • Bullish Pair

Maximum Yield

To gain the greatest yield a liquidity provider is constantly moving his assets from one pool to another. As mentioned at the start of this article volatility, depth, volume and slippage fees are important variables to keep an eye on. Delphi’s pool list and runedata.info will aid you in identifying the most profitable pools. On runedata.info it’s easy to see in which direction returns are trending.

If you’re comparing your returns against holding both assets 50:50, aka LP vs HODL, you’ll need to factor in impermanent loss (=IL). You can use the same approach as above, but now look at the red line ‘total gains’ on runedata.info. Total gains = Fees - IL.

Since IL is such a controversial and complex topic, I’ll write a separate article about this in the future. For now I’ll refer you to Grassrootscrypto’s guide and the following thread on Twitter created by @Krugman25: https://twitter.com/krugman25/status/1316909688877965313

Stable Yield

The pools with the most constant yield, have deep liquidity both on Thorchain and secondary markets. Think BTC, ETH and BNB. Internal and external liquidity is a pre for a high and constant yield. Deep liquidity gives arbitrageurs the opportunity to trade more and bigger volumes. Which causes the pool in question to accumulate more fees, especially in times of volatility.

See the two graphs below. Go to runedata.info and take a look at the historic returns over the past months. Pools where fees and total gains increase at a constant and stable rate are a good choice if you’re looking for a stable yield.

Liquid Pool
Illiquid Pool

Bullish Pair

What I’m about to write might be subjective, depending on how long you’ve been active in the cryptosphere and how you interpret risk.

If you’re equally bullish on both assets in the pool and believe the rate of change will be similar, eg. you expect both assets to increase by 1000% over the coming year it’s hard to lose by being a liquidity provider.

You will hold both assets, the pool automatically balances the assets when one increases vs the other and all the while you’re collecting fees. IL isn’t a factor, because you’re expecting both assets to achieve the same growth, thus nullifying it.

How to track your returns

The community built a few different tools to track returns. I recommend using at least one of them. They will help you understand how the pools function in different situations and help you gain valuable insights. These tools are still being tested; bugs might be present. Nonetheless they’re a must for every serious LP:

· Skittles spreadsheet template

· Runestake.info

Another valuable tool which deserves a mention is runedata.info. This tool shows you the historical performance of each individual pool and compares it against holding either asset or both. You can also see your future returns. In a future article we’ll explore these tools in-depth.

How to track your returns

If you have any questions or would like me to elaborate on a topic, don’t hesitate to ask in the comments or on Twitter.

In the next articles I’ll explain the incentive pendulum in detail and we’ll take a better look at impermanent loss, for now I’ll refer you to Grassrootcrypto’s video guide.

If you’d like to read more articles/guides about Thorchain check this Medium page out. Thorchain.org is also chock full of quality information, I’d suggest taking a look there as well.

Written by Bitcoin_Sage

Twitter: @Bitcoin_Sage

Medium: @Bitcoin-Sage

Published by Thorchain

Main Thorchain interface: chaosnet.bepswap.com

Official documentation: docs.thorchain.org

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