Introduction
An introduction to Gamma and concentrated liquidity
For most of the history of cryptocurrencies, assets were only tradable through a centralized broker or directly peer-to-peer. Decentralized exchanges emerged in 2016 and 2017, but were inefficient, centralized, and had poor liquidity.
In late 2018, Uniswap V1, the first true Automated Market Maker(AMM), premiered.
Uniswap introduced decentralized liquidity pools. Users, now christened "liquidity providers" or "LPs" could deposit their assets into two-sided liquidity pools to provide liquidity for ERC-20/ETH pairs, earning fees in the process. This was later expanded to ERC-20/ERC-20 pairs on Uniswap V2. The math behind Uniswap kept trading fast and efficient.
Uniswap's AMM model became the dominant decentralized exchange model. Numerous forks and variations of Uniswap emerged. Also, protocols began incentivizing liquidity providers with rewards to increase liquidity in pools.
A long-term problem emerged in this growth period, though. Uniswap was not as efficient as it could be. Liquidity could only be provided full-range, meaning that liquidity providers (LPs) were having to provide liquidity far outside the ranges of the current price of the assets.
A solution to the full-range problem came in March 2021. Uniswap released Uniswap V3. Uniswap V3 allowed users to choose the range (via ticks) at which they wanted to provide liquidity.
This relatively simple change had dramatic effects on the market. Liquidity pools became an order of magnitude more efficient. Fees increased to those who provided liquidity within the proper ranges. Full-range positions became uncompetitive. The liquidity concentration and range began adjusting in real time to match the needed liquidity for any pool. A dynamic new market emerged in the world of liquidity.
For some time in 2022, there were doubts about the sustainability and profitability of concentrated liquidity. But the model survived and continues to dominate trade volume on various chains.
Concentrated liquidity did have several unexpected side effects, though.
Concentrated liquidity pools introduced a new risk into the act of providing liquidity called impermanent loss. Mitigating impermanent loss is challenging, and providing liquidity became significantly more complex and risky for the average user. The demand for incentivized pools did not end either. In fact, it only grew due to the challenging nature of concentrated liquidity. Other issues popped up around protocols deploying their own liquidity correctly.
Gamma was created to solve and mitigate these side effects. Gamma mitigates impermanent loss and extracts fees through proper management. Gamma automates actions such as ranging, rebalancing, and compounding to manage liquidity actively. Finally, Gamma provides a platform for protocols to provide incentives to liquidity providers and have their own liquidity pools managed correctly.
Fees and impermanent loss are the forms of yield and risk, respectively, for concentrated liquidity. Liquidity providers and Gamma seek to maximize fee production and minimize impermanent loss.
Fees are driven by volume or, in other words, more trading happening. More volume equals more fees. But, in concentrated liquidity, fees are also driven by concentration and range. An LP that concentrates their liquidity near the trading price will receive significantly more fees than someone who sets their ranges wide and spreads their liquidity thinly.
Impermanent loss is notoriously annoying to explain. But, at the core, it's any losses LPs sustain from the changing prices and ratio of the assets the LPs deposited into the pool. Those losses happen because the prices of the assets go up or down (it happens both ways), and the ratios of the assets change from your deposit to your withdrawal.
Examples: If a user deposited $1000 a pool and later withdrew $800, and holding that deposit would have been worth $900, then the user experienced $100 of impermanent losses. Likewise, if the LP withdrew $1200, and holding that deposit was worth $1300, then the LP experienced $100 of impermanent losses.
It is mathematically possible separate and measure the fee production and impermanent loss of any liquidity position, but it's far easier to evaluate the performance of an LP position by comparing holding the assets at the exact ratio at the time of deposit.
A note on gas. Gas costs to maintain a vault/pool also count against an LP's yield, but the fees are only statistically relevant on certain blockchains. With some costs to rebalance $20+ and some costing less than $0.10.
If the fees > IL, the Gamma vs HOLD will be positive. If the IL > fees, the Gamma vs. Hold will be negative.
One last thing about impermanent loss, is that it's only "permanent" if it's realized. Meaning the vault/pool is rebalanced. Rebalancing is sometimes necessary but generally avoided if possible due to the downsides of impermanent loss.
Last modified 1d ago