Author: Leo
LSDfi rose to prominence with the upgrade of Ethereum, like a torrent that swept through the entire DeFi space, bringing about the LSD (Liquidity Staking Derivatives) war. LSDfi refers to a system where pledgers can convert their staked ETH into tradable assets, thereby increasing liquidity. Additionally, LSD lowers the threshold for users to stake ETH by allowing any amount to be staked, and enables them to earn LST after staking, while also providing multiple sources of income. Alongside enhancing liquidity, it also solves the problem of idle ETH in users' hands, bringing significant TVL to many DeFi protocols focused on the LSD track.
Besides riding the wave of Ethereum's upgrade, LSDfi's explosive popularity is primarily due to its practical solution for crypto users' earnings, making it an important part of the DeFi narrative. Today, we will delve into a new narrative known as LPDfi (Liquidity Providing Derivatives), and mainly focus on the problems of poor liquidity in the DeFi space and how the emergence of LPDfi tackles those issues. Will it become the next major story in DeFi?
Liquidity Issues in DeFi Protocols
Previously, the release of Uniswap V3 significantly improved capital efficiency in the DeFi market but also brought some liquidity issues. For example, liquidity providers using CLMM (Concentrated Liquidity Market Makers) face strategic challenges. The main problem with CLMM is the continual rebalancing of LP positions to avoid impermanent loss. This strategy is often complex and difficult to execute.
There have also been protocols in the market that provide active liquidity management solutions to handle algorithmic MM strategies. Such protocols are crucial for CLMM. However, currently, liquidity management protocols are only effective to a relatively wide extent. Many market makers attempt to avoid asset volatility by purchasing options, but the liquidity of DeFi options is also insufficient, and hedging impermanent loss comes at a high cost. Moreover, options can be a complex concept for retail investors. In the DeFi space, there is no option basket that can effectively hedge impermanent loss from active LP positions.
Another strategy to hedge impermanent loss is to short volatility assets using Money Markets (AAVE or Compound), which has proven to be effective but with relatively low capital efficiency. Currently, all methods to hedge impermanent loss cannot fully leverage the potential of Uniswap V3, which is a problem that Logarithm Finance is actively trying to solve.
Logarithm Finance and LPDfi
First, let's briefly introduce Logarithm Finance. Logarithm Finance is a decentralized liquidity management and market-making protocol designed for market makers and DeFi users. Users do not need to constantly manage their positions to find high APY but can profit from market-making activities.
The concept of LPDfi introduced by Logarithm Finance aims to transfer liquidity across various LPDs and hedge volatility assets, achieving the highest available market capital efficiency. Logarithm Finance primarily provides liquidity for LP-oriented protocols and actively manages LP positions to earn higher returns. The protocol focuses on earning automatic compounding fees on Uniswap-like AMMs and minimizing the risk of volatility assets through Delta-neutral strategies that create short positions on composable DEXs.
Currently, users can join their official DC and wait for the release of the BETA version.
Logarithm Finance Products
Logarithm Finance will launch two main products - Nautilus Vault and Liquidity Shell, Logarithm plays an important role in guiding LPD liquidity (Liquidity Shell) and hedging impermanent loss throughout the development of the LPDfi narrative.
Liquidity Shell - The main product of LPDfi narrative
Logarithm Liquidity Shell helps Logarithm users increase their yield by routing LP tokens to the best liquidity venues in the market. It is also the main product guiding the emerging LPDfi narrative. Simply put, Liquidity Shell can be seen as a yield aggregator platform or liquidity router, aiming to provide Logarithm users with the highest possible yield by deploying deposited assets into various strategies of LPDfi protocols (Panoptic, Smilee, Infinity Pools, Limitless, etc.).
In addition to bringing high returns to users, this product is also beneficial to other LPDfi protocols. Essentially, its liquidity routing mechanism can bring better liquidity to LPDfi protocols like Panoptic and Smilee, thereby improving the liquidity of DEXs like Uni V3. Furthermore, Liquidity Shell is able to eliminate the costs, risks, and complexities associated with liquidity mining. These different aspects of the LP process can be simplified because it is built on top of LPDfi protocols.
In the future, Liquidity Shell plans to enable cross-chain functionality to improve LP routing efficiency, allowing users to access wider returns and bring liquidity to LPDfi protocols beyond Ethereum and L2. Ultimately, Logarithm aims to be the destination for LPD liquidity.
Liquidity Shell operates by guiding user deposits into the highest-yielding strategy protocols in LPDfi to maximize efficiency. Users are able to deposit single-sided liquidity and decide whether to use the Nautilus Vaults strategy. If users choose to use Nautilus Vaults, their LP positions will be hedged using the GMX perps Delta neutral strategy. Additionally, users can choose to bypass Nautilus Vaults and only use Liquidity Shell, through which they will achieve higher returns through asset deployment strategies.
Nautilus Vault - Derivative Product of LPDfi Narrative
Nautilus Vaults is Logarithm Finance's first product, where users can deposit USDC to access high APR strategies. Logarithm Finance will utilize the logic of Nautilus Vaults to develop other products such as Liquidity Shell and leveraged LP mining, releasing more liquidity for liquidity providers.
The operation method of Nautilus Vaults is that users need to deposit USDC into Nautilus Vaults. There is no time limit for adding and withdrawing liquidity, but depending on market volatility, there may be TVL limitations. The scale of the Vaults depends on the available liquidity on decentralized derivatives trading platforms. Nautilus Vaults is committed to partnering with other trading platforms to achieve the maximum market capacity of Vaults.
When USDC is deposited, the protocol will open active and high-volume LP positions on Uniswap V3 within a narrow range and hedge volatile assets using decentralized derivatives trading platforms. Backtest data shows that Nautilus Vaults offers an APR of over 12%.
Users can choose auto-compound APR to achieve more significant returns. All deposits are in the form of USDC. In the future, Logarithm Finance also plans to build other products based on Nautilus Vaults. For example, creating a comprehensive liquidity management layer on LP-centric protocols.
LPDfi Development Prospects
In summary, the advantages of LPDfi include:
1. Cross-chain liquidity aggregation: LPDfi aggregates liquidity from different chains, bridging the divide between various DEXs and achieving true cross-chain liquidity, allowing users to freely move assets between different chains.
Improved fund utilization efficiency. In LPDfi, the liquidity provided by users can simultaneously serve multiple DEX, enhancing fund utilization efficiency. Users can enjoy high liquidity while earning more profits.
Decentralized risk and increased stability. LPDfi achieves decentralized risk by maintaining liquidity reserves on different chains. Compared to relying on a single platform, LPDfi has stronger stability and risk resistance.
Reduced slippage and improved transaction execution efficiency. Liquidity aggregation reduces transaction slippage within LPDfi, resulting in lower costs and higher execution efficiency for users.
Therefore, Logarithm Finance has the potential to become a cross-chain liquidity hub, connecting the entire decentralized trading network and advancing DeFi to a more advanced stage.
Introduction to some other LPDfi projects
In addition to Logarithm, there are other LPDfi protocols in the market:
Panoptic is an options DeFi protocol based on Uniswap. The protocol utilizes Uniswap v3 liquidity positions for minting, trading, and market-making of options available 24/7.
Limitless Finance is a leverage tool built on top of Uniswap V3, which is non-liquidation and permissionless. It aggregates spot and lending liquidity under one framework, reducing the fragmentation between trading and lending liquidity. Limitless mitigates impermanent loss and provides higher yields for liquidity providers. Borrowers will be able to borrow any liquidity assets provided by LPs. They enjoy non-liquidation and extremely high LTVs by paying a premium to LPs (lenders). Traders can long/short assets with leverage of up to 2000x without being subject to forced liquidation based on price.
Smilee Finance is the first protocol for decentralized volatile assets. It provides liquidity similar to DEX to earn predictable USDC APR and hedge on-chain asset risks, aiming to reduce impermanent loss. Additionally, Smilee can be used to build new volatility products, such as inverse impermanent income, where short LP positions profit from impermanent loss.
Infinity Pools requires no further introduction, you can refer to "InfinityPools: 1000x leverage perpetual contracts without liquidation?" for more information.
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