No More Impermanent Loss

Transcript

I'm uh Michael, founder of Curve and Yield Basis, and uh I will talk about uh actually Yield More Yield Basis, which is essentially a strategy uh running on top of uh on top of a special uh Curve Pool uh turned into a its own uh protocol. So, um well, I guess uh right now it's kind of an institutional time, so everyone is looking for a real scalable yield, and um which uh options do we have for uh scalable yield on

um on on crypto. And I'm not talking about yield based on uh incentives. I'm talking about um like real yield. So, what do we What options do we have? We obviously have lending, which uh produces um yield by someone paying interest. And um it actually works, uh especially for USD denominated things, but when you lend out, I don't know, wBTC for example, the real yield in lending for that is uh fairly small.

that's kind of not great, so maybe people would rather hold uh BTC in its pure form without without actually lending platforms, right? So, there are also basis trades, which are fairly interesting for USD. ETH is doing that for USD, but for crypto basis trades don't quite work because everyone is Even now, everyone is similarly uh too bullish on crypto. So, you can't really earn on basis trades on crypto.

Um well, you also can do like covered calls and options and stuff and that obviously works, but it's not really crypto denominated. It's uh something which caps you upside. So, also not very good to earn yield on crypto. Um well, obviously a natural choice would be to earn on crypto by providing it in automatic market makers, but you have this problem of impermanent loss which was always haunting automatic market makers and uh as a Curve founder, I definitely agree on that. Like why Curve why Curve is uh is essentially is fairly popular is

because uh the most of the Curve use case is stablecoin to stablecoin market making which is uh not really having uh not really affected by impermanent loss. But, what about crypto to stablecoin, right? Uh and of course, something which does work and is loved by all the um like institutions and everything is uh staking. So, there are staking ETFs which earn yield on ether or maybe on sol and that obviously works, but uh you know, that's uh only available for staked assets and uh well, maybe you can actually make more there, right?

And apparently, it appears that it's possible to solve impermanent loss and that's what uh I did with Yield Basis and Yield Basis have been running for uh for about 1 year. So, I wanted to review 1 year of data, how it actually performed in um well in uh in in this time of the market which went from essentially top to hopefully bottom, right? Um So, let's see.

Um well, first of all, how how Yield Basis works and uh why, right? So, if you look at the simplest possible liquidity pool, let's say um I don't know uh constant product pool like Uniswap 2, right? Um it's um like pricing function is very non-linear. It's a square root function. If you take exactly the same assets and instead of putting them on in an AMM, put them on a shelf and let them do nothing, then if you uh disregard the fees earned, the assets doing nothing will actually do

better than your um non-linear payoff function of uh of AMM, which is what we call impermanent loss. So, is it possible to get rid of it? Apparently, the answer is yes. So, if you have something like a square root, you you want to get rid of it. Uh what do you do? How do you make it linear? Well, I guess you want to square it. And uh what do you do to square it in DeFi? Apparently, you can do it. Uh you apply leverage.

For so, for leverage and and it's compounded leverage. So, let's say you uh have your liquidity BTC to USD uh in this example, and you borrow um you borrow USD against uh like half half value of this liquidity in USD and buy more of this liquidity to keep this ratio of like uh debt versus liquidity being always around factor of two. When you do that, then you essentially have the price squared and square root disappears and you have fees earned, so looks like magically solves IL. And question is, does it actually solve IL? Apparently,

it does, but the returns part is something which is tricky because uh you do spend something to keep this leverage constant, right? Because you need to um buy LP with what you borrowed or sell LP to repay some of what you borrowed, so that is um that costs, right? And you essentially need to earn more than than you you have you lose.

And um apparently, if you have AMM like Uniswap 2, that wouldn't work because you would earn uh about exactly as much as you lose to keep your leverage constant. But if you have some concentrated liquidity, that already helps. Um coincidentally, in Curve uh since 2021, we have crypto pools which do have concentrated liquidity which is automatically managed. Um but it's not always moved like to the current price. This concentrated liquidity follows the price only when there are you know, there is a reserve to move it, right? So, there is if there is this

reserve is empty, the concentrated liquidity is stuck until more returns are earned and then they are spent to move it, right? So, anyway, it's whether you will have enough reserves depends on parameters of these crypto pools and uh um yeah, so we did some modifications for that in your basis and uh basically applied this how we call it re-leverage method to to get rid of impermanent loss.

So in that's how it looked like in simulations, right? So you have on the top you have Bitcoin price over how long that over 2 years I guess, 2 years and a half and how how much how how returns would go over that time. So well sometimes they are going steady up, sometimes they go flat and then steady up again. So looks pretty good. So question is does it work like that in practice?

Well, now we have 1 year of real data to see how it went. And just to well, just to summarize where the returns can go but where the returns go in your basis. So we have income into the system coming as swap fees, right? And you do have expenses. Some of the expenses go to repay moving concentrated liquidity, So moving concentrated liquidity in curve pools cost something.

And another expense is keeping leverage constant. That also costs something. If you have something left this is profit. Where does the profit go? So the profit is split between liquidity providers who have you know, this growth and YB down. So locked YB tokens get get the fees which the system earn, right? And in exchange, because it takes some of the some of the returns away, why whyB essentially has some token emissions,

which go to liquidity providers. And this split between how much is going in token emissions and how much is going in fees is chosen by liquidity providers themselves. So, they can choose whether they earn fees or whether they earn YB tokens. And how much YB dollar gets is also dependent on that. So, in but when we analyze data, we don't want to look at the split. We want to actually see how much the system earned as a whole. So, like essentially how how much profit was left after we after we used the expenses.

And here is what we've got. Right? So, we started with fairly aggressive pool parameters. Which earn really really well. So, you see this dash line showing a simulation, right? But this simulation is at very conservative parameters and we started at fairly aggressive parameters. So, you see the green line going up very very well. But, you know, it's it's aggressive. And what does it mean? It means that sometimes the system and like the stable coin will experience a very serious stress and

we need to run more conservatively. And another kind of another consequence of that is this yield kind of flattening too much because the parameters were too aggressive. So, um we uh and yeah, you you can have some uh losses as well when you have aggressive parameters. So, we changed to more conservative parameters, and that's where you essentially see the green line uh continuing. Um but overall, overall, we are fairly close to what simulation shows, uh and uh we uh figured out how to um well, how to find

balance between good uh like safety of the system and earnings, right? Uh but this work is not uh is not really not really fully complete. We actually want to apply uh two more things to I don't know, to make system safer and at the same time make it uh earn uh earn more. So, one of the things is doing smarter dynamic fees, and um well, uh basically, if volatility becomes higher, you want uh fees to be bigger, right? We do some of that, but it's probably not as optimized as it can be. So, we're

thinking deeply about that, and we can change it without actually any liquidity migration. But another, probably more interesting, is uh dynamics very similar to prop AMMs, where external traders, they actually bring price information into the system. And system utilizes this price information and apparently earns more. It's fairly easy to see in simulations, and as we saw, simulations do match reality, so uh we are configuring that part as well, and it will be live um actually very, very soon.

Anyway, so, we have this uh system uh made, uh battle tested, and uh there are improvements um improvements going where you essentially have impermanent loss solved. That's it.