Ethereum

A few thoughts we have when we calibrate liquidity pools for LSTs/LRTs. Relevant with the (not unexpected) ezETH depeg.

There is a trade-off between LP efficiency and having deep liquidity at depeg prices.

There's also a misconception that you need liquidity everywhere.

🧵👇

🏗️🧑‍🔬 @gyroscope. Decentralized finance, applied math, network science. Prev: PhD at Cornell, analytics MBS/ETFs/indices

When launching a pool, it's worth differentiating two cases:

1) If this pool will be the main source of liquidity for an asset

2) If it's not the main source of liquidity and it's ok for the price to go out of range

When the pool is the main source of liquidity for an asset, you should consider systemic risk in the liquidity design and ensure coverage at depegged prices.

This helps to reduce risk for collateral integrations of this asset, risks which can spread throughout DeFi.

StableSwap pools with moderate amplification tend to effectively fill this role today.

StableSwap provides liquidity at all prices, but it isn't all needed.

LSTs/LRTs tend to have high frictions to redeem but not mint.

While you may want wide downside liquidity, you can still improve efficiency a lot by removing the part above peg.

If your pool is case 1), often it may need to rely on incentives to keep the pool profitable for LPs as the capital won't be able to be used at peak efficiency at most times.

In case 2), you can focus your pool design to be most profitable for LPs and accept that the pool may move out of range.

Most @gyroscope pools have fit into case 2) so far, but they can also be calibrated as more efficient case 1) pools.

What determines if a pool is the 'main source of liquidity' or not?

One important part is whether there is another venue with deep liquidity where price discovery happens. This is important both for oracles to source prices and for other pools to arbitrage against.

Traditionally, these have been CEX markets, but they are increasingly DEX markets for LSTs, LRTs, and decentralized stablecoins.

Which makes liquidity design of AMMs more important.

A related complication that affects which type you fit in is when assets go across chains.

Slow bridges add significant frictions and increase the need for deep liquidity on multiple chains vs being able to arbitrage with deep liquidity that exists on other chains.

DAI gives a good example of this slow bridge friction.

DAI tends to trade at a discount to USDC on chains with slow bridges because bridging DAI back to Ethereum can take 7 days whereas bridging USDC is fast.

Even though on Ethereum DAI is (normally) convertible with USDC.

Lastly, how GYD design connects with these ideas.

GYD is primarily traded through reasonably tight pools for GYD/{USDC, USDT, DAI} and a somewhat wider pool for GHO.

This works well b/c GYD can be atomically minted and redeemed = price support outside of these pools.

StableSwap provides liquidity at all prices, but it isn't all needed.

LSTs/LRTs tend to have high frictions to redeem but not mint.

While you may want wide downside liquidity, you can still improve efficiency a lot by removing the part above peg.
https://twitter.com/aklamun/status/1776947144991072719