Delphi Labs and Attic Labs Announce Cosmos-Compatible Passive Concentrated Liquidity (PCL)
As discussed in Finding a New Home for Labs, Delphi Labs has been focused on protocol research and development in the Cosmos ecosystem — particularly in the Automated Market Maker (AMM) space.
With the deployment of Uniswap late in 2018, AMMs found immediate product-market fit in the young world of decentralized finance (DeFi). Suddenly, traders everywhere could create their own liquidity pools, which anyone else could trade against.
Bypassing the need for centralized exchanges, DeFi had found its Big Bang moment.
On paper, the experiment should have failed. Driven by a simple mathematical formula (x*y=k), AMMs were conceptually hard to understand. Liquidity was low. Fees were high and LPs risked impermanent loss — losing more value by pooling their assets than simply holding them.
Uniswap defied conventional wisdom, though. The protocol flourished, eventually serving as the backbone for liquidity during DeFi Summer and inspiring a legion of other DEXes on Ethereum and beyond. Today, more than $15 billion in total value locked (TVL) is ready to trade on the 650+ DEXes tracked on DeFiLlama.
The rise of concentrated liquidity
On May 5, 2021, Uniswap v3 unveiled a new innovation. Dubbed concentrated liquidity, this new approach abandoned the pricing curve in CPP pools and instead allowed LPs to supply liquidity into pools within custom price ranges.
A fundamental breakthrough, it gave LPs more control, increased efficiency, and lowered the risk of impermanent loss.
In many ways, though, Uniswap had philosophically changed. It stopped facilitating “automated” market making in favor of active rebalancing, much like traditional market-making. This tipped the advantage toward active or professional market makers; not the everyday LPs who made Uniswap v1 and v2 such a success. While several project teams have launched new protocols to make Uniswap v3’s rebalancing process easier, they’ve largely failed to attract users.
Meanwhile, there’s still massive demand for passive LP’ing as demonstrated by the ~$10 billion that remains in CPP pools. What if there was a way to combine the two approaches?
Over the past eight months, developers at Delphi Labs and Attic Labs have been working on a solution to do exactly that — a special form of concentrated liquidity compatible with Terra 2 and other Cosmos chains. The code has been published on Github and is currently under audit.
Introducing passive concentrated liquidity (PCL) pools to the Cosmos
As their name implies, concentrated liquidity pools concentrate (or amplify) liquidity around a particular price. Existing stableswap pools on Terra 2 and other Cosmos ecosystem chains offer a great example of a very specific type of concentrated liquidity. They work by concentrating liquidity around a 1:1 ratio for assets such as stablecoins.
Specifically, stableswap pools introduce an amplification parameter to the standard constant product pool formula. This amplification parameter (A) determines how close the stableswap curve should be to the standard XYK constant product curve. For example, an amplification value of 0 (A = 0) achieves results identical to the constant product pool algorithm; higher values of A push the curve closer to the constant price curve, resulting in lower slippage for exchange rates close to 1:1.
It’s an approach that works great for assets trading at or near the same price. But what about token pairs with high volatility and non-correlated prices? Delphi Labs and Attic Labs’ proposed passive concentrated liquidity (PCL) pools would tackle this problem much like Uniswap competitor Curve v2: by algorithmically amplifying liquidity around current market prices for any pair of tokens.
Doing that requires the help of a repegging algorithm. This algorithm looks at ongoing trades and rebalances liquidity and fees around the exponential moving average of those trades. The moving average determines a specific price range around which to amplify trades. If prices move outside the range, the repegging algorithm automatically sets a new price range.
In other words, this approach offers the benefits of Uniswap v3 without requiring active management. It truly is passive or “automated” market making.
The power of PCL
The PCL approach has three core benefits:
1. Capital efficiency.
Constant product pools require extremely deep liquidity to ensure lower slippage on trades. By concentrating liquidity around a specific price, PCL pools need only a fraction of the depth of CPPs to offer superior execution.
2. Toxic flow mitigation.
Concentrating or amplifying liquidity is a double-edged sword. By amplifying liquidity around a specific price, it increases capital efficiency. However, it also amplifies the risk of impermanent loss and toxic flow (value extraction by arbitrageurs) for LPs during volatile periods when the prices of two tokens in a pool diverge.
PCL attempts to mitigate this risk by introducing dynamic fees. Instead of a fixed fee, fees would automatically adjust higher or lower based on volatility. This means LPs receive larger rewards during times of volatility (i.e. when real prices most diverge from the exponential moving average).
With this approach, pool creators would have the option of setting a range for their fees between 5 basis points (0.05%) and 40 basis points (0.40%), and the fees would then dynamically adjust based on market volatility. In many ways, this approach is similar to traditional market making. Market makers widen their bid-ask spreads during volatility (effectively charging more on trades). PCL pools can mimic this “upcharge” via automatically-adjusted fees, which aim to offset impermanent loss via fee income.
Data backs up this approach. A recent research report from Delphi Digital found that Curve v2’s PCL pools have could have resulted in superior price execution for leading stablecoin swaps via the “Tricrypto” pool — even over Uniswap v3’s more actively-managed pools.
3. Passive LPing
Uniswap v3 gives LPs more control by allowing them to manually set a specific price range where they’d like to deploy their liquidity. With a PCL approach, an AMM would instead automatically adjust the acceptable price range based on the exponential moving average of the tokens in the pool. This means LPs could provide liquidity once and rest assured that their tokens would still be serving as active liquidity on the AMM. Uniswap v3, on the other hand, forces LPs to adjust their price range manually if and when the price moves out of their pre-determined range. In other words, this approach prioritizes passive LP’ing over more granular (and labor-intensive) control.
Deploying PCL on Astroport and beyond
Delphi Labs and Attic Labs have completed principal development of the PCL AMM code as a fork of the Astroport protocol, and are awaiting audit results for finalization. Look for a proposal from them in Astroport’s Forums soon. There, Astroport users can weigh in on the pros and cons of this approach. Based on community feedback, the proposal could be taken to a vote for implementation before Astroport’s governing body, the Astral Assembly.
Follow Delphi Labs on Twitter to get alerted when the proposal launches, and prepare to join the Astral Assembly in the debate.
This article is for educational purposes only; nothing herein is intended to be relied upon as advice, promises, representations, warranties or otherwise.