Double Significantly Reduces Impermanent Loss for Capital Providers (Part 1)
Capital Providers (or Investors) in Double are defined as users who supply the capital side of an AMM pool, which is typically stablecoins (DAI, USDC, USDT), WETH, WBTC or any type that is configured as the capital type by the protocol. By design, in Double, capital providers are in the driver seat, and make every decision regarding AMM LP positions. They decide which AMMs to work with, which tokens to supply liquidity, how much capital to supply, when to create and when to close AMM LP positions. We assume and expect capital providers understand the rewards and risks associated with providing liquidity for any token on any AMM.
(Note: like any DeFi project, there will be potential technical risks with smart contracts. The team will try its best to eliminate any technical risk. But the discussion here is not about technical risks.)
Impermanent Loss (IL) risk is a well-known risk (maybe even the biggest risk) for AMM liquidity providers. IL is a very hard problem to solve (maybe a problem that cannot or should not be solved since if there is no risk, there should be no reward). Double is NOT designed to eliminate but rather significantly reduce the IL risk.
The collaboration model designed in Double is similar to the market making model that is widely used between projects and professional market makers to provide liquidity on CEX — New Wine in Old Bottles. In Double, projects lend their tokens to capital providers for free (e.g. fees earned by AMM LP positions all go to capital providers). But when closing their AMM LP positions, capital providers need to pay back the same NUMBER of tokens they borrow, NOT the same VALUE they borrow. Because of this unique and elegant design, when token prices go down, Double will significantly reduce impermanent loss for capital providers compared to not using Double.
Let’s use an example to illustrate how Double can significantly reduce impermanent loss for capital providers. Here is the setup: 1) A hypothetical token MOON is trading at $1 or 1 USDC; 2) a capital provider is creating a LP position for the AMM pool <MOON, USDC> with 1000 MOON + 1000 USDC. Without using Double, the capital provider needs to allocate 2000 USDC, swap 1000 USDC for 1000 MOON first and then add the pair 1000 MOON + 1000 USDC to the AMM. With Double, the capital provider only needs to allocate 1000 USDC, the protocol will borrow 1000 MOON and add the pair 1000 MOON + 1000 USDC to the AMM.
When MOON token price goes down, if the capital provider wants to close the LP position, the Double protocol will receive more than 1000 MOON and fewer than 1000 USDC back from the AMM, plus fees earned of course which are in both USDC and MOON.
For example, if the MOON token price goes down from $1 to $0.9, the Double protocol will receive 1054.093 MOON and 948.683 USDC from the AMM as shown in the table below. In this scenario, the capital provider will have more than 1000 MOON to pay back the tokens it borrows. The Double protocol will repay the 1000 MOON, send the remaining 54.093 MOON, 948.683 USDC, plus fees earned to the capital provider.
When capital providers close LP positions, the impermanent loss becomes Permanent Loss (PL). As shown in the table below, when the token price goes down to $0.9, with Double, the PL for the capital provider is $2.633 ($1000 — $948.683–54.093*$0.9 = $2.633); without Double, the PL for the capital provider is $102.633 ($2000 — $948.683–1054.093*$0.9 = $102.633) since the capital provider needs to swap 1000 USDC to 1000 DBL first. The PL with Double is 2.57% of the PL without Double, a significant (97.43%) reduction in IL/PL.
More importantly, by significantly reducing impermanent loss for capital providers, Double can make most AMM pools offer “positive risk-adjusted APY” to capital providers. In the above example, let’s use the fee earned by the position is 10% ($200 = $2000 * 10%) or 20% ($400 = $2000 * 20%). As shown in the table below, with Double, the capital provider can still earn a positive return even when the token price drops about 70% to $0.3 if the fee is 10% ($200) or 90% to $0.1 if the fee is 20% ($400). On the other hand, without Double, the capital provider will lose money when the token price drops only about 20% to $0.8 if the fee is 10% ($200) or 40% to $0.6 if the fee is 20% ($400). Clearly, the chance for capital providers to lose money in Double is much lower than without Double!
Unfortunately, the chance that the prices of many legit tokens drop 90%+ from all-time-high is not 0. There are still a few easy ways for capital providers to earn a positive return. First, capital providers should try their best NOT to create AMM LP positions when token prices are around all-time-high. Second, they should either directly or indirectly via liquidity management tools such as Gamma Strategies, Sommelier to adjust their AMM LP positions, for example, close their profitable positions when token prices drop by 30%-40% and create those AMM LP positions again at the lower price points. Third, capital providers can increase their earnings via incentives from Double and/or token projects that only need to offer small incentives, a significant improvement compared to the current liquidity mining incentives.
To conclude, Double has a unique and elegant design that significantly reduces impermanent loss for capital providers and makes most AMM pools offer “positive risk-adjusted APY” to capital providers when the token prices go down. Stay tuned for part 2, which will illustrate how Double can even eliminate impermanent loss for capital providers when token prices go up.
