Decentralized exchanges (DEXs) have become an integral part of cryptocurrencies, bringing liquidity to hundreds of tokens. Around $67 billion in capital has been provided by liquidity providers for DEXs in 2022, allowing users all over the world to own and trade hundreds of tokens. However, impermanent loss remains a key risk for liquidity providers on DEXs, reducing or eliminating returns made from trading fees. The need to deal with impermanent loss has become crucial for cryptocurrencies, as lower liquidity in DEXs could harm global adoption.
As part of the Genius Yield platform, the Genius DEX will become the first order-book DEX with concentrated liquidity built on Cardano that eliminates impermanent loss. The order-book model that the Genius DEX uses is similar to other major centralized exchanges. The most widely used DEXs built on blockchains such as Ethereum use the Automated Market Maker (AMM) model, which causes impermanent loss. By not using the AMM model, the Genius DEX eliminates impermanent loss while also giving traders the same dynamic functionality of order-book exchanges.
What is Impermanent Loss?
Impermanent loss happens for liquidity providers when the value of their deposited assets in an AMM DEX is lower than if they had just held the assets. The AMM DEX was invented as a solution to having a DEX on account-based blockchains like Ethereum. Due to Ethereum’s account based model that requires serialization of transactions to a global state, an order-book exchange where different transactions can happen in parallel to each other is cost prohibitive and improbable for an account based model.
To allow a functioning DEX on account models like Ethereum, the AMM DEX was introduced, which uses the constant product formula, x*y = k. The formula dictates the ratio that two assets must trade at for every transaction in a liquidity pool. As trades happen, the ratio of the assets could diverge from the market prices on centralized exchanges, causing impermanent loss for all liquidity providers with capital in a liquidity pool.
The Solution — The Genius DEX Eliminates Impermanent Loss
The Genius DEX eliminates impermanent loss because it does not utilize the AMM model and its constant product formula. Therefore, the Genius DEX does not have impermanent loss. Instead, the Genius DEX uses the order-book model, which allows liquidity providers to create fragmented liquidity positions. Liquidity providers can also use concentrated liquidity on the Genius DEX, which allows them to designate what the price their fragmented liquidity positions can trade at for an asset pair. There is no fixed liquidity curve like the AMM model that dictates prices for every liquidity provider. While the Genius DEX eliminates the risk of impermanent loss, there are still risks to using any DEX.
Cardano’s EUTxO Model Benefits
The Genius DEX has an innovative architecture that takes full advantage of the properties inherent in Cardano’s EUTxO model. The EUTxO model allows for parallel transaction processing, scalability, and determinism. The Genius DEX provides an efficient and cost-effective way for users to trade and for liquidity providers to optimize their return on capital.
Why Impermanent Loss is Important
Many tokens are based on decentralized applications (dApps) that perform important functions such as lending & borrowing or decentralized storage. Many dApps would lose liquidity and functionality without DEXs. Impermanent loss could lead to liquidity providers removing their capital from DEXs, which could slow the growth of cryptocurrencies around the world.
More questions on Impermanent Loss?
Impermanent loss is a complex topic, that’s why Genius Yield created an eBook that goes into more detail. To get a deep dive on impermanent loss, visit the website and download this free eBook: The 2022 Ultimate Guide to Impermanent Loss, and how to avoid it.
What comes next?
Genius Yield is committed to using its technology to democratize access to decentralized finance (DeFi). The Genius DEX is expected to be released in 3Q 2022 as part of that effort.
About Genius Yield
While DeFi provides many investment opportunities, managing capital is both complex and time-consuming. Genius Yield is your all-in-one solution to benefit from advanced algorithmic trading strategies and yield optimization opportunities. Genius Yield’s Smart Liquidity Management protocol will be intuitive, hassle-free, and secure. Genius Yield minimizes risk and maximizes profits.
“The 2022 Ultimate Guide to Impermanent Loss, and how to avoid it” eBook is available under this link.
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Original Source: https://www.theblockcrypto.com/post/143389/how-to-eliminate-impermanent-loss-with-the-genius-dex
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The Blueshift team took three different approaches to reduce Impermanent loss(IL) which ultimately led to a reduction of IL for Blueshift users by a factor of 2, up to a factor of 10. In other words, Impermanent Loss on Blueshift is commonly 10 times lower than on other DEXes.
Let’s examine each approach and how it impacts Impermanent Loss for Blueshift users.
Impermanent Loss is an occurrence that happens when the ratio of provided assets changes in a liquidity pool. This implies that if only a single asset is provided as liquidity in a liquidity portfolio with multiple cryptocurrencies — Impermanent Loss is significantly reduced.
By placing 3–40 different token types in a liquidity pool, which for the sake of differentiation and clarification, we call a liquidity portfolio — the impermanent loss is directly reduced due to changes of parameters that are part of the AMM formula. The correlation between the impermanent loss and the number of types of cryptocurrencies in a pool has been already described in a subsection titled ‘Number of token types in the pool’ which is part of the previous article.
The liquidity portfolio innovation will be utilized by Blueshift from the very beginning, as well as the following innovation: the ‘Blueshift reserve model’.
One of the roles that benefit from impermanent losses is seemingly invisible but takes its cut nonetheless. The primary driver of impermanent loss is ultimately the price change of assets, which is a reflection of the ratio of tokens in a liquidity pool. In other words, trends primarily cause impermanent losses. However, arbitrageurs are one of the primary catalysts of price change actions on marketplaces.
It can then be said without question that, when an arbitrageur executes a net positive value transaction, a part of that net positive was essentially taken from the liquidity providers.
Blueshift’s solution to this occurrence is to get arbitrageurs to forgo a part of their profits in order to utilize the zero-fee or negative fee arbitrage that is offered by the platform. These ‘profits’ that arbitrageurs relinquished now stay in the pockets of Liquidity providers.
In other words, the Blueshift platform forgoes the arbitrageur’s fee, and in return, arbitrageurs provide a part of their net positive transaction to liquidity providers. And hence, the entire ecosystem benefits, because liquidity providing has even higher incentives, and almost automatically — a greater number of participants.
A different way of explaining this phenomenon is as follows. Due to smaller reserves used by the Arbitrageur, which are necessary to be used in order to execute a zero or negative fee arbitrage — the Impermanent Loss curve is skewed in favour of Liquidity Providers by temporarily modifying the ratio between assets. This in turn results in higher slippage for Arbitrageurs, however, it will commonly pay off for Arbitrageurs to utilize such a feature.
Price oracles allow for token price change to decouple from the token reserves themselves, which ultimately determine the ratio between assets and hence impermanent loss. If the price is changed without an arbitrage, or a standard trade, the reserves remain unchanged, and hence, impermanent loss remains unchanged as well.
In the following article ‘Impermanent Loss on Blueshift’ we will dive even deeper into Blueshift technology, crunch some numbers and get concrete data on Blueshift’s edge as a liquidity management platform.
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For clarity, liquidity portfolios in this article were mostly referred to as ‘liquidity pools’. Liquidity portfolios are in essence — liquidity pools that contain more than just 2 types of cryptocurrencies.
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