Michael Egorov, the founder of Curve, recently released a paper about this in DeFi. In it, the team describes an innovative strategy that promises to remove the risk of impermanent loss (IL) for liquidity providers. Egorov’s new platform, Yield Basis (YB), takes this concept and goes a step further, introducing a fully market-driven model with single-asset exposure at its core. This approach provides increased yield guarantees compared to classical Automated Market Maker (AMM) architectures. Backtests of this strategy over just six years supposedly indicate tremendous outperformance. ThrowingToken.com takes an in-depth look at this new approach, why it can be advantageous, and what dangers liquidity providers should look for.
Understanding Yield Basis and Its Mechanism
Yield Basis (YB) is a new protocol made to solve the age-old problem of impermanent loss rooted in DeFi. Using lending and re-leveraging mechanisms, the platform’s yield model allows even BTC liquidity pools to earn stable yields. First, YB makes it easier for liquidity providers to participate by letting them deposit one asset rather than the typical two-asset setup. Further, this creative new approach might be able to lure different types of participants.
At the heart of YB’s theory of change is a flexible leverage model. In this model, the liquidity ratio fluctuates depending on market conditions and the model borrows crvUSD. In this way, YB hopes to maximize returns and limit the negative effect of impermanent loss. This fluid recalibration is incredibly important to realizing ongoing stability and profitability in the speculative, fluctuating flow of DeFi. Here, the British Virgin Islands and the Cayman Islands are increasingly coming into vogue as domiciles for single-asset funds. This trend not only demonstrates the popularity of this investment strategy.
Benefits of Single-Asset Exposure
The main benefit of YB is its single-asset exposure, which makes providing liquidity to the fund a much more straightforward exercise. Capital efficiency Additionally, liquidity providers are freed from the burden of having to manage two separate assets and all the stress that comes with their ever-changing valuation. This makes it much easier to try things out. This serves to reduce the occurrence of impermanent loss, which occurs when the value of deposited assets varies.
While single-sided liquidity (SSL) provides protection from impermanent loss, it doesn’t take away all the risk factors related to cryptocurrency investing. By concentrating liquidity on a specific asset, liquidity providers have more control over their investment. By taking a more strategic and planned approach, the returns become much more predictable. As Egorov’s backtests indicate, this method can outperform regular AMM setups. This renders it an attractive choice for virtually anyone interested in earning passive yield in the DeFi ecosystem.
Decoding the APR Estimation Formula and Rewards Distribution
Project liquidity providers (LPs) are the main winners from earning returns on their tokens. This yield is typically quoted as an annual percentage yield (APY). This return is derived from two primary sources: fees collected from swaps and rewards distributed in the form of tokens. Take, for instance, a BTC/RUNE LP — they would earn trading fees in both BTC and RUNE, as well as reward structures in RUNE tokens.
With many liquidity pool models, the distribution of these rewards is determined by pool depth or fees earned from swaps. Similar to situations where a block has 0 swaps, when the reward depends on the size of the pools, it assigns the incentive based on pool size. The deeper the pool, the nearer the member will come to owning their pool share worth equal to their unique whole. The larger the pool, the nearer the member will come to owning their pool share value equal to their initial value. This mechanism allows liquidity providers to be rewarded fairly according to their relative contribution to the pool’s total liquidity.
Potential Risks and Considerations
Even though single-sided liquidity (SSL) provides protection against impermanent loss, it doesn’t remove every risk factor tied to crypto investing. Second, it’s important to understand that SSL is not a free lunch. SSL exposes buyers and sellers to market liquidity risk. Market liquidity risk is when you can’t unload an asset in a timely manner. This occurs simply due to a lack of buyers, creating an inability to easily access a competitive price.
Another risk to think about is funding liquidity risk. This means taking stock of the company’s short-term or easily liquidated assets and weighing them against the company’s obligations. Liquidity providers would do well to consider their own funding liquidity risk when providing liquidity via SSL. Price range risks are relevant. When it comes to impermanent loss, liquidity providers are able to mitigate this risk by choosing a specified price range. Their primary risk is that if the price of their token moves outside this limited range, their liquidity will not be tapped.
Egorov has found a smarter way to scale away impermanent loss with single-asset liquidity on Yield Basis. This offers an exciting new opportunity for liquidity providers looking to earn passive yield in DeFi. Before jumping in, it’s important to recognize the risks, think critically about the mechanism, and know what you’re getting into.
