How it works
Concentrated Liquidity
In WEMIX.Fi's total deposits, liquidity is evenly distributed along the price curve x*y=k, and assets are deposited across all exchange rate (price) ranges from 0 to infinity. However, most pools don't effectively utilize this broad liquidity distribution. For example, in a specific pool, only around 0.5% of the capital is used within the price range of $0.99 to $1.01, which typically sees the highest trading volume and fees.
Furthermore, total deposits result in only a fraction of a liquidity provider's capital being allocated to earn returns. This means that users holding a substantial amount of tokens may not receive compensation for price risks like impermanent loss. Additionally, with liquidity spread across all price ranges, swap users might experience significant slippage.
In contrast, WEMIX.Fi's Range Deposit allows liquidity providers to concentrate their capital within their preferred price ranges. This enables liquidity providers to create individualized price curves that align with their preferences.
Liquidity providers can combine multiple Range Deposit positions within a single pool. For example, in the WEMIX-WEMIX$ pool, a provider can allocate $100 within the $1.50-$2.00 range and an additional $50 within the $1.50-$1.75 range.
Users trade based on the combined liquidity from all individual curves, and the transaction fees collected at each price range are distributed proportionally to the amount of liquidity supplied by the liquidity provider within that range.
Capital Efficiency
Concentrating assets allows liquidity providers (LPs) to minimize risk by supplying less capital while maintaining the same liquidity depth. The saved capital can be allocated elsewhere, held, or used to expand liquidity within specified price ranges to earn more transaction fees.
For example, let's consider two users, Cheolsu and Yeonghee, who want to provide liquidity to WEMIX.Fi's WEMIX-WEMIX$ pool. Each of them has $1,000. The current price of WEMIX is 1.5 WEMIX$.
Cheolsu follows the previous WEMIX.Fi's total deposit approach and diversifies his capital across the entire price range. He deposits 500 WEMIX$ and 333.33 WEMIX, totaling $1,000.
On the other hand, Yeonghee creates a position to deposit her assets only within the price range of 1.0 to 2.0. She deposits 100 WEMIX$ and 66.67 WEMIX, which is roughly worth $200. She can use the remaining $800 as she pleases.
Cheolsu has deposited five times more capital than Yeonghee, but if the WEMIX/WEMIX$ price remains within the range of 1.0 to 2.0, they will earn similar amounts of fees.
Yeonghee's customized position serves the role of limiting losses for specific types of liquidity. If the price of WEMIX were to drop to $0, both Cheolsu and Yeonghee's liquidity would be in WEMIX. Yeonghee can use the additional $800 she has for mitigating downside risks or for other investment strategies.
Range Deposit liquidity providers can offer a greater depth of liquidity with the same funds compared to total deposits liquidity providers. They accept more price risk (impermanent loss) to support more trades, earn more fees, and provide deeper liquidity.
Liquidity pool
The liquidity pool of WEMIX.Fi is itself a smart contract that allows users to swap crypto assets through an AMM. The swap rate between the token pair is formed based on the x*y=k equation. The lower the liquidity of the pool, the greater the swap rate of token pairs, causing preventable losses such as slippage and price impact. It is essential to secure abundant liquidity to minimize losses to users and support stable exchanges.
WEMIX.Fi provides initial liquidity for the pool and encourages user participation to generate more trades. If users supply liquidity directly to the pool, they can earn a portion of the swap fee according to the amount of supplied liquidity. A portion of the fee (0.25% of assets) paid by users when exchanging tokens is distributed proportional to the share of the users who have provided liquidity, and thus, the users who provide more liquidity will be able to earn a larger share. A user's share of the pool is represented through their LP token.
The value of the token pairs that make up the liquidity pool is maintained at 1:1. If the ratio deviates from 1:1, an arbitrage opportunity arises and returns to 1:1 through active arbitrage swaps. The liquidity supplied by users is deposited at a 1:1 ratio to keep it stable and prevent excessive arbitrage. If the user decides to deposit the tokens at their own desired ratio, the token with more value will be partially swapped and deposited in the pool to maintain the token ratio at 1:1.
See Swap for more information on how tokens are traded between users and liquidity pools, as well as slippage and price impact.
Impermanent loss
Impermanent loss is defined as the loss of value deposited in a liquidity pool when compared to holding onto it in a wallet during price flunctuations. Thus, users can earn profits by providing liquidity, but losses might occur due to price differences. For example:
Let's assume a user deposits 10 WEMIX and 1,000 WEMIX$ in the WEMIX-WEMIX$ pool when the price of WEMIX is $100 and WEMIX$ at $1, providing a total liquidity worth of $2,000 which is equivalent to 10% of the total liquidity in the pool.
Soon after, the price of WEMIX increases from $100 to $150, and due to user arbitrages, the quantity of WEMIX decreases, while the quantity of WEMIX$ increases. The quantity of each tokens that make up the pool is at 81.65 WEMIX and 12,247 WEMIX$, leaving a total value of $24,494.5 in liquidity. If a user withdraws at this point of time, they will receive $2,449.5 since their share of the pool is 10%.
If the user had not deposited the assets, the value of 10 WEMIX and 1,000 WEMIX$ would have gone from $2,000 to $2,500. Therefore, the user loses about $50 (2.0%) by withdrawing from the pool.
Impermanent loss occurs due to the fluctuation of prices. The extent of the loss is difficult to predict, so users need to closely monitor the pool's expected return and market conditions. Impermanent loss due to price fluctuations can be expressed as below:
1.25x price change results in a 0.6% loss relative to holding
1.50x price change results in a 2.0% loss relative to holding
1.75x price change results in a 3.8% loss relative to holding
2x price change results in a 5.7% loss relative to holding
3x price change results in a 13.4% loss relative to holding
4x price change results in a 20.0% loss relative to holding
5x price change results in a 25.5% loss relative to holding
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