Liquidity Provision in CLMM
In the last article we went over the differences in DEX V2 and DEX V3 in terms of how liquidity functions, but in this article we will focus on what it looks like to be a liquidity provider.
DEX V2
In DEX V2, new liquidity is added in a 50/50 value split at whatever pool ratio is currently trading. If a user wants to provide $100 of FLR to the FLR/HLN LP, they must also add $100 of HLN to balance the position. Depositing this liquidity results in fungible ERC-20 LP tokens that represent the share of the total pool being minted to the depositor, which can then be held, traded, or staked in a Farm where available. When trading occurs against the LP, every position moves in the same way so that every LP token is backed by the same amount of each asset relative to the other LP tokens.
This means that when you pair 2 assets at a certain ratio, you are entering a trading position in which you are willing to swap one asset for the other as their respective value ratios change. In V2 this range extends from approaching 0 to infinity which means only a small portion of your actual liquidity is being used for market making swaps at any given time. This limits the actual asset balance change of one directional price movements on your position (IL), but also limits the fees you are gaining since only a small portion of your actual LP is being utilized for swaps.
DEX V3
In DEX V3, every liquidity position is unique.
The balance of tokens required to open a position is determined by the selected tick ranges and their relation to the current trading price. Tick ranges involve complex math based on a calculation of trading fee and liquidity, but it is more easily understood as essentially being a price range into which liquidity is concentrated. Because a liquidity position can be opened at any price range, including both in range and out of range positions, each position has a unique ID and is represented by a unique NFT.
This NFT is the key to accessing the underlying position liquidity, as well as claiming fees, delegation rewards, FlareDrops, and incentives.
Because DEX V3 allows you to set the specific trading range in which you would like to provide liquidity, liquidity providers have much more control over where and when their assets are traded. However, this also means that the relative balance of assets in your position changes much more quickly and has endpoints. If the relative value of Asset A falls to the bottom of your range, then you would be 100% in Asset A. If it rises to the top of your trading range, you would be 100% in asset B. This means that within that range, more of your liquidity is being used for swaps, up to 100% of each side of your LP at the extremes of the range. This increases the effects of IL from one directional movement, but also increases your fees gained because more of your assets are being used for swaps.
Position Examples
For example, let’s say you open a concentrated liquidity position for FLR/eUSDT with a current price of 0.027 eUSDT/ 1 FLR, and set a tick range of 0.02–0.035. If the price of FLR dropped to 0.02, all of your eUSDT would have been swapped for FLR. However, if the price were to rise to 0.035 then all of your FLR would have been swapped for eUSDT. If FLR trades within this range, then your ratio would move back and forth between the two assets while generating far more trading fees per $ than a v2 pool would.
Effectively, you would be entering a trading position in which you DCA into FLR as the price falls, and take profits as the price rises. The rate at which you DCA in or out is determined by how broad of a range you set, with 100% in or out being the extremes.
You can also open out of range, single sided positions which would function similar to a limit order. In this way you could open a position with 100% eUSDT at 0.015–0.02 and if the FLR price fell to that level, then your eUSDT would begin to be swapped for FLR at 0.02. Or, open a position with 100% FLR at 0.035–0.04 and then if the price ratio of FLR increased to 0.035, your FLR would be used to swap for eUSDT within that range.
But why stop at one position? In DEX V3, liquidity providers can open as many positions as they would like at whatever ranges they choose. If you were to combine the 3 examples above, you would have:
- A 2-sided position which covered the current active range, earning you fees and incentives as long as FLR traded in the 0.02–0.035 range.
- A single sided FLR position which would begin to sell FLR for eUSDT from 0.035–0.04.
- And, a single sided eUSDT position which would begin to buy FLR with eUSDT from 0.02–0.015.
Using a straddle strategy like this you could provide various amounts of liquidity along the price curve, earning fees and taking advantage of volatility spikes.
Making it Easy
Now, while unlimited flexibility can be a great thing, we understand that sometimes having unlimited choices can be overwhelming. That’s why we created 3 preset liquidity options to offer alongside the custom option.
- Aggressive : This strategy sets a relatively narrow range across the current price. Targets higher fees and incentives, but increases risk.
- Conservative : This strategy sets a wider range across the current price. Better for longer term positions that seek to accumulate fees and incentives within a broad trading channel.
- Full : This strategy creates a position that covers the full range from 0 to infinity and will act very similar to a DEX V2 position.
- Custom : This option allows full flexibility where in range and out of range positions can be input numerically or using the liquidity slider available on the liquidity chart.
DEX V3 adds unparalleled levels of flexibility (and complexity) to the current trading environment available on Ēnosys.
Hopefully this article provided a little more insight into how liquidity positions work and how liquidity providers can create near limitless trading strategies directly on the DEX.
In the next article, we will talk about fees, L1 rewards, and the novel incentive system we have built into DEX V3.
