November 7, 2022: $UNI-directional Losses
Competing threads highlight challenges for concentrated liquidity LPs
A hotly debated thread this weekend provides a number of important lessons for the broader DeFi community.
The short summary is that former high frequency trader @thiccythot_ released a dashboard showing that LPs in an AMM called Uniswap were badly underwater, to the tune of $100MM over the course of a year. This is big if true — it would land the protocol writ large within the top 20 on the Rekt leaderboard just for going about its day to day business.
The claim was initially rebutted by the team from Uniswap, claiming that trading fees actually made it profitable to the tune of $150MM.
This is another bold claim. Just sitting around and twiddling your thumbs can earn nine figures?
On closer inspection, @0x💩Trader found an error in Uniswap’s calculations that brought the numbers more in line with the original $150MM loss figure. The protocol was inadvertently(?) only counting positive trades and zeroing out the negative trades.
The Uniswap team did not address this rebuttal, opening the court for dunk practice.
A few other threads popped up attempting to contextualize the debate.
For our sake, we’re withholding judgement, as it appears it may not be so cut and dry. The great @nagakingg, who’s RSVP-ed to be guest of honor at this Friday’s Llama Party, cites a flaw in the original thread which the author has also left unaddressed.
We therefore feel it’s too early to comment on the veracity of any of the competing threads. Credit to Naga for being willing to throw cold water on calculations that might otherwise help his bags. To their great credit, I’ve found several members of the Curve community to be more interested in technical accuracy than spreading pleasant fictions that might cause a short term pump.
We confess we have a heavy bias towards user safety. Our default take is that LPs should keep their distance if they lack comprehension of any particular protocol. Best to wait on the sidelines and inform yourself of all the risks before making a calculated decision to put your funds in jeopardy. This strategy would even keep users out of TriCrypto, one of our favorite tokens, because very few understand it.
We remain very skeptical about retail investors serving as an LP to Uniswap pools. In addition to plentiful anecdotes of LPs losing money, we’ve even seen some formal research on the subject. More recent research has also suggested the protocol disproportionately consists of scam tokens:
In fairness to Uniswap, this may be more an indication of the general state of cryptocurrency than any knock against their protocol. Open the floodgates and you’ll wind up with a current of raw sewage. In fact, we previously questioned whether Curve’s focus on quality control is in fact hampering it relative to Uniswap.
For more research, here are a few threads contextualizing Uniswap v3 more broadly relative to Curve.
Without drawing any conclusions about the truth of any particular threads, we can point to some general takeaways.
Concentrated Liquidity is Tough for LPs
In our research, we’ve yet to hear many consistently successful strategies for making positive returns for serving as an LP within Uniswap’s v3 concentrated liquidity pools. That’s not to say it’s necessarily impossible, but for the moment we recommend beginners steer clear.
Our understanding is that the premise of the Uniswap v3 concentrated liquidity pools was a sort of an “if you build it, they will come” type strategem. That is, the Uniswap team appears to have expected that builders would fill in the gaps and create the tools to rebalance concentrated liquidity in a gas efficient manner as markets moved, so that passive LPs might have opportunity to profit.
To date we’ve not observed such tools actually being built (commenters please shill your solutions if this is wrong!) We don’t expect it’s impossible, just that none have yet actually solved it.
Somewhat ironically, the closest thing to a “solution” may be Curve v2 pools. Such pools don’t have specific public-facing liquidity tranches, but they do feature the only natively “smart” AMM that algorithmically rebalances interal liquidity around the current target price, essentially offering a passive LP experience.
For this reason, in the wake of the recent Uniswap thread wars, Curve suggested directly a solution would be to start tracking data on LP profitability in different services.
It’s a good opportunity for somebody to build a @thiccythot__ style Dune dashboard, but one focused on Curve’s TriCrypto pool instead of Uniswap’s ETH/USD pair. I don’t actually know what such a dashboard would show (it may well be bad for Curve), but it would nonetheless be a useful resource.
Alternate to building a Dune dashboard, this data could also be grabbed from subgraphs, which should already be archiving all the necessary data.
More generally, a DeFiLlama section on LP profitability would be particularly useful!
Of course, there are some nuances around how exactly you skin this cat. What strategy do you compare as the base case? Holding ETH? Dollars? A 50-50 blend? As it turns out, lately nothing beats holding the good ole’ dollar, but that won’t stop us degens from trying.
Another potential strategy is essentially to short such LP pools — bet they will lose value and turn impermanent loss into impermanent gain. Enter GammaSwap labs:
Several Wrong Takes is Greater Than The Sum of Each Take
Another important lesson is that a multitude of bad takes is the best strategy for us innocent bystanders to arrive at anything resembling truth.
Even though all crypto Web3 data is publicly available on chain, that doesn’t always make it easy to interpret. The correct interpretation of these data are complicated and highly dependent on circumstances. The best we might hope for is a million interpretations.
A nice thing happens in the internet public commons. Presenting an opinion that’s too obviously stupid or incorrect gets seized on instantly by a million reply guys (maybe reply gals too? Is there such a phenomenon?) More nuanced takes don’t tend to elicit such ratios. The truth lies somewhere near the epicenter of this swarm of collisions.
Beware, then, the popular misconception that “misinformation” be defined as “incorrect information.” Since information emerges from collisions, the only way to reduce the surface of available information is to artificially restrict such debate. Ergo the only real “misinformation” is in fact censorship.
One Person Can Make a Difference
You can do it!
When you see complex mathematical analysis, most people just shrug their shoulders and assume it’s correct. Often times though, very few people ever put any scrutiny on anything. Literally anybody can ask questions and add value to the conversation.
This whole thing started because @thiccythot__ was brave enough to post some analysis in public. Others felt emboldened to chime in. The barriers to entry in other swaths of our society are quite high: one person may not easily be able to influence our political system, corporate propaganda, or broader cultural debates.
Yet crypto has more tokens being created than it has people examining their nuances. It’s never been easier for a single person to study a single token in depth, ask some questions, and achieve outsized influence within a particular sphere.
Seize this opportunity for your gain.
Question Everything
The most important lesson, which we may as well extrapolate to our entire lives, is the importance of skepticism.
Lately some people have learned that a lone researcher with a keyboard is often better able to strike at the truth than any number of well-pedigreed and impeccably credentialed experts.
Now, extreme skepticism makes life difficult to live. Society as we know it requires intermingling networks built on trust. Our best bet is to ask questions of all claims, and lend trust to those who habitually provide answers that withstand basic scrutiny.
Unfortunately this attitude makes crypto quite boring. If you don’t like Ponzi Schemes, you’re gonna have a bad time. Skeptics may sit on the sidelines, anxiously watching fellow degens netting a 100x on the latest doggie ponzi.
Over the long run though, you may well find it more effective if your strategy focuses on incrementally gaining exposure to solid projects. Not financial advice™️
Disclaimers! Among mentioned assets, author has exposure to TriCrypto.