ThorChain: Liquidity Pools

Creating a LP position with your KeepKey

In the decentralized finance (DeFi) space, liquidity pools are crucial for facilitating trading on blockchain networks. This guide will introduce you to creating a Liquidity Provider (LP) position using KeepKey and explore the ThorChain ecosystem.

Concepts

• KeepKey: Get a KeepKey here. https://keepkey.com
• Demo: (Don’t have a KeepKey yet?) You can still follow along with this tutorial on ShapeShift "demo mode".

ThorChain

• ThorChain: An innovative open protocol designed to maintain a network that facilitates cross-chain liquidity swaps. By enabling users to exchange cryptocurrencies across different blockchains seamlessly, ThorChain stands at the forefront of solving the interoperability challenges in DeFi.

ShapeShift

• ShapeShift: Recognized as one of the premier decentralized applications (dApps) on ThorChain, ShapeShift offers a user-friendly interface that allows for effortless cryptocurrency exchanges and interactions with various DeFi services.

How To 101: Using ShapeShift

Some of you have already noticed a new label in ShapeShift's menu.

In this post, we will review the process to create an LP position.

Selecting a pool.

All Pools are paired with RUNE. If you need RUNE, it is recommended you first trade into RUNE.

Let's create a new Liquidity position.

Notice that this trade has 2 assets going into it: Bitcoin and RUNE. The amount “max” you can trade is the max value of the lowest balance. For instance, if you had 10,000 USD worth of Bitcoin and 15,000 USD worth of RUNE, the max position you can make is 10,000 BTC 10,000 RUNE (for a symmetric position). An asymmetric LP add simply adds a swap into the LP action, resulting in slippage from the swap action inside and on exit of the pool.

This final result.

Notes, you may need to restart the application between the second transaction. If this happens, you will simply load ShapeShift back up, select pools, and an “incomplete” transaction will show. You can continue this transaction on the right-hand side.

After completing the LP add, you will be able to view your position under “Your Positions”.

High APY (Greater Than Savers)

At the time of writing this article, DAI is presenting 267% APY.

I will be updating this article in the future and showing the position's progress. It is unlikely this will stay this high for long. As the pool increases its liquidity, the APY will go down. Low liquidity and high volume pools show a very high APY; however, the total fees collected are much lower than larger pools.

It's important to understand that these APYs can swing wildly and even go negative on shallow markets.

Historical APY

(Source) https://thorchain.net/insights/apr

The High-Reward Proposition

At the outset, the allure of becoming an LP on platforms like ThorChain is compelling. As of the latest data, opportunities to earn exceedingly high annual percentage yields (APYs) — such as a 267% APY on DAI — are not uncommon. These returns are generated from the fees collected from trades executed within the liquidity pools, with earnings directly related to the volume and frequency of these trades.

Liquidity pools operate on the principle of Automated Market Makers (AMMs), using algorithms to price assets based on their ratio in the pool. This model facilitates decentralized trading around the clock, providing liquidity providers with a passive income stream from their staked assets.

Furthermore, ThorChain’s innovative approach, utilizing Continuous Liquidity Pools (CLPs) and its native token, RUNE, as a base for all trades, amplifies the potential for LPs to reap significant rewards under the right market conditions.

Liquidity Provision (LP)

In decentralized finance (DeFi) platforms like THORSwap, offers significant yield opportunities but comes with its share of complexities and risks. Understanding these intricacies is crucial for anyone considering becoming a liquidity provider. Key among these challenges are the concepts of divergent loss (commonly known as impermanent loss), smart contract vulnerabilities, and the unpredictability of market movements.

Divergent Loss Explained

When you commit assets to a liquidity pool, you exchange a portion of your holdings for another asset to maintain a balanced portfolio within the pool. For example, in THORSwap, entering a pool requires converting half of your RUNE into another asset, resulting in a diversified holding rather than a single asset. This diversification is fundamental to liquidity pools, which aim to maintain a balanced ratio between two assets.

However, this leads to what’s termed as divergent loss, particularly in volatile markets. If the value of one asset in the pool rises significantly while the other remains stable or falls, the dollar value of your pooled assets could be less than if you had simply held onto your original holdings. This effect is exacerbated in pools with highly uncorrelated assets.

Impermanent Loss Mitigation Strategies

THORChain, recognizing the challenges posed by divergent loss, offers mechanisms to mitigate its impact:

• Slip-Based Fees: Instead of a fixed transaction fee, THORChain utilizes slip-based fees, which dynamically adjust based on transaction sizes and pool liquidity, incentivizing liquidity where it’s most needed and potentially reducing divergent loss risk.
• Network and Liquidity Incentives: To compensate for the opportunity cost of locking assets in a liquidity pool, THORChain rewards liquidity providers with network and liquidity incentives, which can offset or even negate the effects of divergent loss over time.

Strategic Pool Participation

For a more risk-averse approach to liquidity provision, participating in pools with highly correlated assets (e.g., stablecoin pairs like USDT and DAI, or asset pairs like ETH and sETH) can minimize divergent loss. These pools are less likely to experience the drastic value divergences that trigger significant impermanent losses.

Conversely, entering pools with highly uncorrelated assets increases the risk of divergent loss. However, if the assets eventually normalize in value relative to each other, the divergent loss can be reversed, showcasing the impermanent nature of this risk.

The Indispensable Role of LPs

Despite these challenges, liquidity providers play a critical role in the DeFi ecosystem. By enabling efficient, decentralized trading without traditional order books, LPs facilitate a more inclusive financial system.

Be a #Thorchad. Provide LP today.

---