Liquid Staking Liquidity

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Matt Czernik
Matt Czernik

The LST Meta

The beacon chain launch was pivotal for the ecosystem and its enthusiastic participants. A new "risk-free rate" emerged, allowing anyone with 32 ETH to earn a 4% APY on their favorite token by running a validator. Long-term holders rejoiced at the prospect of passively watching their ETH balance grow.

Enter Lido Finance, a platform that streamlined access to this novel yield opportunity. By allowing users to deposit ETH and receive stETH in return, Lido enabled every degen to partake in the 4% APY, regardless of their ETH balance. With stETH in hand, the question became: what's next?

DeFi's composability offers several avenues for leveraging yield-bearing ETH. For example, users can lend their stETH on platforms like Maker, Aave, or Compound or provide liquidity on an AMM (Or a mix of both!).

Since the merge, AMM designers have diligently worked to create optimal liquidity solutions for Liquid Staking Tokens (LSTs). Traditionally, AMMs have excelled at handling "mean-reverting" pairs, where the prices of the two assets are expected to converge frequently, such as USDC<>USDT or USDC<>DAI. However, non-rebasing LSTs like cbETH or wstETH present a unique challenge. These assets represent a claim on an ever-increasing balance of ETH on the beacon chain, making them "inflationary" relative to ETH, barring tail risks.

The inflationary nature of LSTs makes them suboptimal for traditional AMM liquidity provision, as they don't exactly satisfy the "mean-reverting" property. Naively providing liquidity on a weth<>cbETH pair would result in stale orders that deteriorate with each block due to the continuous inflation of cbETH. Arbitrageurs would exploit these orders, leading to potential losses for liquidity providers over time (LVR).

AMM designers have taken on the challenge of mitigating the downsides of providing liquidity with LSTs. Several protocols, including Primitive, have developed innovative solutions to address this issue. In the following sections, we'll develop a surface-level overview of some LST AMMs and explain how Primitive aims to contribute to this ecosystem.

The Central Hubs of LST Liquidity

Uniswap V3

Uniswap V3 is a widely adopted trading platform in DeFi, often serving as the default interface for trading most assets. However, passively providing liquidity to Uniswap V3 for wstETH<>wETH pairs exposes positions to impermanent loss due to the expected price divergence between the two assets. Manually rebalancing positions incurs high portfolio maintenance costs from fees and slippage. To optimize Uniswap V3 liquidity provision, users can leverage automated liquidity management solutions to minimize portfolio maintenance costs. Uniswap V3 benefits significantly from its outsized flows relative to other protocols, so if LPs manage their range effectively and minimize rebalancing costs, it's an excellent baseline solution for LST pairs.

Curve CryptoPools V2

Unlike the original Curve stableswap invariant, CryptoSwap pools are designed for assets not directly pegged to each other, such as wstETH<>wETH. CryptoSwap pools concentrate liquidity around a price determined by an internal oracle. Initially, a CryptoSwap pool has a 50/50 weight, meaning a wstETH<>wETH pool would be composed of 50% wstETH and 50% wETH by value. Weights are computed on each trade based on the Oracle price and continuously updated to target a pool composition that minimizes impermanent loss for LPs and slippage for traders. The weight updates aim to push the pool reserves towards weights that maximize capital efficiency while protecting LPs from impermanent loss.

Balancer Composable Stable Pools

Balancer Composable Stable Pools utilize a stableswap invariant and integrate with a rate provider that supplies the price for the underlying yield-bearing asset (e.g., wstETH). By leveraging the rate provider, Composable Stable Pools minimize the risk of providing stale prices as the value of wstETH increases relative to ETH. LPs incur some notion of Oracle risk but benefit significantly from the quotes provided by the rate provider.

Gyrostable Elliptic Concentrated Liquidity Pools (E-CLP)

Gyro ECLPs offer more granular control over concentrated liquidity than the stableswap invariant. Pool deployers can manage liquidity bounds and dispersion, enabling highly customized liquidity management. ECLPs also integrate directly with Balancer, gaining first-class support for the rate providers to track the divergence between wstETH and ETH. The additional customizability allows for pools more effectively tailored to the expectations of various tokens, making them an excellent choice for passive LPs who want to get the most out of their assets.

Primitive LogNormal Pools

Primitive LogNormal Pools are based on the original implementation of the covered call pool from the RMMs paper. The pool parameterization has been refined to allow gradual adjustments to sigma (implied volatility) and K (the strike price). Adjusting sigma increases the concentration of liquidity around the strike price K. Updating the strike price causes liquidity to centralize around the chosen price progressively. With LogNormal Pools, users can create managed concentrated liquidity pools that minimize LVR by adapting to changing market conditions.

As the DeFi landscape evolves, innovative AMM designs are emerging to address the unique challenges posed by yield-bearing assets like LSTs. By offering tailored solutions for concentrated liquidity, dynamic pricing, and impermanent loss mitigation, these new AMM architectures are paving the way for more efficient and profitable liquidity provision in the post-merge era. Primitive's LogNormal Pools represent our contribution to this exciting frontier, empowering users to create adaptive, concentrated liquidity pools that respond to shifting market dynamics.