Liquidity — The Liquidity Pool, Staking and Rewards
What exactly is liquidity?
Many people do “research” on coins and find out info about the contracts, the devs, the marketing team, etc. But one thing that is often overlooked is the amount of liquidity the token or coin has.
The short of what liquidity actually is, means that if x amount of people pulled out of a coin, how long would it take until the coin is “liquidated” or, has no liquidity so it goes to zero.
Looking at many coins today, this number is much lower than most people realize. I will not point out any specific coins here but let me just tell you, the average token has less than 20% liquidity.
What that means is that if someone managed to sell every token in existence, the maximum they would receive is 20% of the “value” of the tokens. For example, a coin or token with a 10 million market cap, that has 20% liquidity, if all tokens were sold at the same time, the maximum that would come out of that is $2,000,000.
So what does that mean for old hedge and new hedge? While we had a whale event last week, our liquidity actually remained relatively steady.
We did lose about 15% overall, but we have fully rebounded since then and actually have more liquidity today than we did on that day, even though the price is below that level.
Why is liquidity important?
Having strong liquidity is super important to the longevity of any specific project. We fully understand that people have bills to pay, and investors will sometimes have reached an investment level and it is time to redeploy capital for whatever reason.
Because of this, every coin on the market today has a liquidity battle ahead of them. But is there a way to fix it?
How can the new Hedge fix this liquidity issue, so it’s never an issue again?
So this was interesting, to say the least. Obviously, we had to make a few things happen and put quite a few things in motion.
First and foremost is the practice of bonding. What this does is eliminate sell pressure and only increases buy pressure. It does this by removing all outstanding Hedge from the open market giving us the opportunity to stabilize the price while also controlling the supply. If you have not already done so, please read the previous article on bonding.
Next is the liquidity pool rewards system. In previous iterations of Hedge, you simply bonded your current tokens and got a minimal reward when someone unstaked their hedge.
Listen, we all know rewards are good and great, but wouldn’t it be smarter to get rewards for actually helping to sustain the protocol?
So the new hedge is taking a different approach and entirely different stance on staking. Instead of “blind staking” which means putting your tokens into the protocol essentially for fun, we’re now going to require you to stake LP tokens.
What is an LP token?
An LP token is a paired token of New Hedge and BUSD. One side of the LP token is a stable coin and the other is the new hedge. In many protocols, the pairing is done with another unstable asset (for instance BNB).
What this means if that BNB goes up, and the other token goes down, there is a spread that it lost called impermanent loss which essentially can not be recovered since all LP tokens must be 50% one asset 50% the other.
The reason why we decided to go with a stable asset as one side of the liquidity pair is so you’ll never have an impermanent loss from the LP token you stake.
Impermanent loss happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them. The bigger this change is, the more you are exposed to impermanent loss. In this case, the loss means less dollar value at the time of withdrawal than at the time of deposit.
Pools that contain assets that remain in a relatively small price range will be less exposed to impermanent loss. Stablecoins or different wrapped versions of a coin, for example, will stay in a relatively contained price range. In this case, there’s a smaller risk of impermanent loss for liquidity providers (LPs).
So why do liquidity providers still provide liquidity if they’re exposed to potential losses? Well, the impermanent loss can still be counteracted by trading fees. In fact, even pools on Uniswap that are quite exposed to impermanent loss can be profitable thanks to the trading fees.
Uniswap charges 0.3% on every trade that directly goes to liquidity providers. If there’s a lot of trading volume happening in a given pool, it can be profitable to provide liquidity even if the pool is heavily exposed to impermanent loss. This, however, depends on the protocol, the specific pool, the deposited assets, and even wider market conditions.
How does impermanent loss happen?
Let’s go through an example of what impermanent loss may look like for a liquidity provider.
Alice deposits 1 ETH and 100 DAI in a liquidity pool. In this particular automated market maker (AMM), the deposited token pair needs to be of equivalent value. This means that the price of ETH is 100 DAI at the time of deposit. This also means that the dollar value of Alice’s deposit is 200 USD at the time of deposit.
In addition, there’s a total of 10 ETH and 1,000 DAI in the pool — funded by other LPs just like Alice. So, Alice has a 10% share of the pool, and the total liquidity is 10,000.
Let’s say that the price of ETH increases to 400 DAI. While this is happening, arbitrage traders will add DAI to the pool and remove ETH from it until the ratio reflects the current price. Remember, AMMs don’t have order books. What determines the price of the assets in the pool is the ratio between them in the pool. While liquidity remains constant in the pool (10,000), the ratio of the assets in it changes.
If ETH is now 400 DAI, the ratio between how much ETH and how much DAI is in the pool has changed. There is now 5 ETH and 2,000 DAI in the pool, thanks to the work of arbitrage traders.
So, Alice decides to withdraw her funds. As we know from earlier, she’s entitled to a 10% share of the pool. As a result, she can withdraw 0.5 ETH and 200 DAI, totaling 400 USD. She made some nice profits since her deposit of tokens worth 200 USD, right? But wait, what would have happened if she simply holds her 1 ETH and 100 DAI? The combined dollar value of these holdings would be 500 USD now.
We can see that Alice would have been better off by HODLing rather than depositing into the liquidity pool. This is what we call impermanent loss. In this case, Alice’s loss wasn’t that substantial as the initial deposit was a relatively small amount. Keep in mind, however, that impermanent loss can lead to big losses (including a significant portion of the initial deposit).
With that said, Alice’s example completely disregards the trading fees she would have earned for providing liquidity. In many cases, the fees earned would negate the losses and make providing liquidity profitable nevertheless. Even so, it’s crucial to understand impermanent loss before providing liquidity. (Cited from Binance)
What is a liquidity pool and how are rewards earned?
Liquidity Providers earn trading fees. Providing liquidity gives you a reward in the form of trading fees when people use your liquidity pool.
Whenever someone trades on PancakeSwap, the trader pays a 0.25% fee, of which 0.17% is added to the Liquidity Pool of the swap pair they traded on.
- There are 10 LP tokens representing 10 CAKE and 10 BNB tokens.
- 1 LP token = 1 CAKE + 1 BNB
- Someone trades 10 CAKE for 10 BNB.
- Someone else trades 10 BNB for 10 CAKE.
- The CAKE/BNB liquidity pool now has 10.017 CAKE and 10.017 BNB.
- Each LP token is now worth 1.00017 CAKE + 1.00017 BNB.
To make being a liquidity provider even more worth your while, you can also put your LP tokens to work whipping up some fresh yield in the protocol-owned liquidity pool. This poll will then pay rewards to current stakers in the form of “new hedge” while they continue to earn trading fees on the LP token they have staked.
Please note, you always own these LP tokens. By staking them, they can be unstaked and unpaired at any time by you. By providing them to the protocol it eliminates circulating supply while helping to drive the price of the native token up.
So how do I get LP tokens?
There are two ways to get LP tokens in the new version of Hedge. I will go through all of them quickly here, and there will be DETAILED instructions on how to do this once the new protocol is launched.
For this example, we are going to assume you have bonded old hedge, into new hedge and the bonding period has ended so you have now claimed your tokens into your wallet. We are also going to make the assumption the total value of Hedge you hold is $1,000 to make the numbers easy to follow.
Option 1: You have $1000 worth of new hedge tokens in your wallet. You go ahead and get $1000 worth of BUSD into that same wallet. You now go ahead and head to pancake swap and create a 50/50 LP token of 50% “New Hedge” and 50% BUSD totaling $2000 worth of a new LP token.
You can then take those new LP tokens and stake them for more rewards from the protocol and for trading fees.
Option 2: You have $1000 worth of new hedge tokens in your wallet. You head to pancake swap and trade 50% of your new hedge for BUSD. You now go ahead and head to pancake swap and create a 50/50 LP token of 50% “New Hedge” and 50% BUSD totaling $1000 worth of a new LP token.
You can then take those new LP tokens and stake them for more rewards from the protocol and for trading fees.
What is suicide compounding?
Suicide compounding is the act of taking rewards, creating new LP tokens with them, and never putting in more dollars to do this. This does a few things and it’s super important to understand how this works.
So in this example, we’re again going to assume you have bonded new hedge, created your LP tokens, and have also staked them. Depending on the amount you stake, the number of rewards will vary, but for this example, let’s say each day you are rewarded 10 new hedge tokens (again to keep the numbers easy).
On day 1, you will go ahead and claim those rewards. Head over to pancake swap and sell half of those rewards for BUSD. With the remaining half, you will create a new LP token of half “new hedge” and half BUSD. Then again, you will stake that new LP into the protocol.
Now you have created new LP tokens out of thin air. This will do two things. One, you will earn more rewards from the LP as you now have a larger stake of the LP.
You will also receive more rewards from the protocol, again since you own a larger share of the LP. On day two, you may be awarded 11 New Hedge Tokens. You repeat the steps above and continue to suicide compound daily.
What this means is that you’ll be getting rewards, on rewards, without having to invest more (Unless you want to). It also means the more people stake their LP, the fewer circulating tokens will be available, the more liquidity the entire ecosystem will have, and the healthier the entire project will be.
Just keep in mind, suicide compounding does impact sell pressure (it increases it) but that is not necessarily a bad thing. Having a steady and clean increase is always healthier than major pump and dumps in the crypto world.
If we can help to show the world that we have real utility, real rewards, and most important REAL LIQUIDITY we will be one of the healthiest projects in the entire world. As a team, were shooting for 80% or more liquidity within the project.
Can you help us get there? We hope so.
Next article out within 48 hours.