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Lifinity_whitepaper

Lifinity proposes a novel market-making mechanism that addresses issues in decentralized finance (DeFi) by concentrating liquidity, proactively market-making with an oracle, and implementing a rebalancing mechanism. This approach enhances capital efficiency, reduces impermanent loss, and automates liquidity adjustments, benefiting both traders and liquidity providers. The protocol's design allows for improved profitability while minimizing the risks typically associated with concentrated liquidity.

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13 views

Lifinity_whitepaper

Lifinity proposes a novel market-making mechanism that addresses issues in decentralized finance (DeFi) by concentrating liquidity, proactively market-making with an oracle, and implementing a rebalancing mechanism. This approach enhances capital efficiency, reduces impermanent loss, and automates liquidity adjustments, benefiting both traders and liquidity providers. The protocol's design allows for improved profitability while minimizing the risks typically associated with concentrated liquidity.

Uploaded by

qtdaivuong
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Lifinity: A Proactive Market Maker with Concentrated Liquidity

The Lifinity team


April 2022

Introduction

Since their inception in 2018, AMMs have grown to become the core infrastructure of DeFi,
allowing anyone to trade and market make in a few clicks. However, although TVL and
trading volume have shown exponential growth, the underlying technology has seen little
improvement. Issues such as capital inefficiency, impermanent loss, and high fees remain
unsolved, creating costs that are rarely seen in TradFi for both traders and liquidity
providers.

We propose to solve these issues by 1) concentrating liquidity, 2) proactively market mak-


ing using an oracle, and 3) implementing a rebalancing mechanism. Concentrating liquidity
improves capital efficiency for liquidity providers while reducing slippage for traders. By
using an oracle as the key pricing mechanism, the market maker is able to reduce imperma-
nent loss, as it does not rely on arbitrageurs to adjust the price. Lastly, the rebalancing
mechanism ensures that the pool balance regresses to the bonding curve while generating
profit by delaying the rebalancing process.

Concentrated Liquidity

In the constant product model (x ⋅ y = k), liquidity is provided across the price range from 0
to infinity. In contrast, concentrated liquidity adds depth to a market by providing capital in
a limited price range, thereby improving capital efficiency. There are several methods of
concentrating liquidity, but we take the simple yet unique approach of applying leverage to
the value of k. This is achieved by simply multiplying k by the desired level of concentra-
tion c, which determines the amount of liquidity provided:

x⋅y=c⋅k=K
Figure 1: Concentrating liquidity

Proactive Market Making

Although concentrating liquidity improves capital efficiency, it also increases the risk of im-
permanent loss. To minimize this risk, the protocol proactively market makes using an ora-
cle. This frees the pools from reliance on arbitrageurs to adjust the price and can greatly re-
duce or even reverse impermanent loss. Furthermore, since oracles on Solana such as the
Pyth Network provide price updates every slot (about 0.5 seconds), it is extremely difficult
to profitably front run.

Figure 2: Concentrated liquidity moves along the bonding curve


Why does using an oracle reduce the risk of impermanent loss? On constant product AMMs,
every trade that moves the price away from the price at which liquidity was initially de-
posited results in impermanent loss. Using an oracle helps avoid this because the AMM ad-
justs to the “correct” price before arbitrageurs can trade against stale prices, allowing LPs to
avoid impermanent loss that they otherwise would have incurred.

Rebalancing Mechanism

Although this is sufficient for the protocol to efficiently market make, it lacks a mechanism
to keep the pool balanced, which increases the risk of impermanent loss. To minimize this
risk while maximizing profit, the protocol rebalances its pools by adjusting their liquidity.

This adjustment of liquidity occurs on every trade and/or change in oracle price according to
the following formulae:
z
Kadjusted = K ⋅ (x ⋅ p / y) to increase liquidity for x

z
Kadjusted = K ⋅ (y / (x ⋅ p)) to decrease liquidity for x

where K is the total amount of liquidity, p is the price of x provided by the oracle, and z is
the parameter that determines the magnitude of the adjustment.

For example, when x comprises less than 50% of the total value of the pooled assets, the
market maker will decrease liquidity for buyers of x and increase liquidity for sellers of x in
order to regain balance. This will incentivize traders to sell against the pool while discourag-
ing them from buying, ensuring that the pool balance regresses to the bonding curve.

Figure 3: Rebalancing

An additional advantage of implementing a rebalancing mechanism is that the protocol is


able to concentrate liquidity beyond what is reasonable in other concentrated liquidity proto-
cols because it makes it more difficult for the price to go out of the position’s price range.
Rebalancing Scenarios

Let’s consider the possible scenarios that can occur in practice. The pool balance only
changes when users trade with the pool or the oracle price changes. The combination of the
two can generate a profit or a loss for liquidity providers. Below are the four possible sce-
narios and how the protocol handles them:

1) The price of x increases when x comprises more than 50% of the pool
2) The price of x decreases when x comprises less than 50% of the pool
3) The price of x increases when x comprises less than 50% of the pool
4) The price of x decreases when x comprises more than 50% of the pool

1 & 2 are scenarios in favor of liquidity providers since they generate a profit or reverse the
impermanent loss that constant product market makers would incur. The rebalancing mech-
anism effectively buys the dip when prices fall and takes profit when prices rise. These are
the most likely scenarios since the oracle price tends to move faster than the price on other
DEXs and arbitrageurs cannot profitably trade against our pools.

Conversely, 3 & 4 are scenarios that work against liquidity providers. They are less likely to
occur since the oracle price usually moves ahead of other DEXs. In the case that it does hap-
pen, however, the protocol will adjust its liquidity to minimize further impermanent loss.

Conclusion

Although liquidity concentration has heretofore implied greater risk of impermanent loss,
Lifinity has developed a novel market making mechanism that concentrates liquidity even
as it reduces impermanent loss. Further, since liquidity is adjusted automatically according
to an oracle, liquidity providers do not need to actively manage their positions. Lifinity thus
improves both liquidity for traders and the profitability of market making for liquidity
providers.

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