Thank you for your efforts in developing contracts that enable Uniswap LP tokens as collateral. Since similar ideas have been explored by other protocols, we’d like to add some color around the historical context to align our understanding. We are interested in learning the key differentiators of this implementation and how this proposal could drive value to Compound.
Our understanding is that much of this development revolves around active liquidity management, which involves automated strategies to maintain liquidity within the active price range, maximize fee income and mitigate risk based on market conditions. Due to the algorithmic and operational complexity of these strategies, several solutions have emerged in this category, including Arrakis Finance, Gamma, and ICHI. The total value locked (TVL) in this category peaked in 2022 before experiencing a significant decline.
LP performance in Uniswap v3 is closely linked to the effectiveness of the underlying execution strategy and infrastructure. Factors such as range selection, rebalancing cadence and gas costs have a significant impact on profitability. In addition, Just-in-time (JIT) liquidity can also reduce returns for LPs that do not employ similar approaches. Building active liquidity management solutions therefore requires careful consideration of all of these factors, along with the non-trivial risks associated with smart contracts.
Given the challenges of active liquidity management, enabling LP tokens as collateral has been explored as a way to unlock additional value for liquidity providers. Several stablecoin and lending protocols have experimented with enabling LP tokens as collateral, but none have achieved widespread adoption currently.
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Aave V2 AMM Market (mentioned by @allthecolors)
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Maker GUNIV3DAIUSDC
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Adopted in September 2021 and gained significant market share in 2022. The debt ceiling was reduced to zero during the Silicon Valley Bank collapse/USDC depeg incident and has not been reprioritized since.
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YLDR: An Aave fork that allows leveraging Uniswap v3 positions and borrowing against them. It has not gained significant market share.
The current smart contract implementation tokenizes Uniswap v3 positions into fungible ERC-20 tokens with a customized Rebalancer contract to automate liquidity range adjustments and fee compounding. This approach seems similar to Arrakis Finance’s (rebranded from Gelato Network) G-UNI.
Questions
- Use Cases for Uniswap v3 LP as Collateral
- Based on the earlier examples, one of the few use cases that gained traction is borrowing stablecoins against stable-stable pair LPs (i.e., GUNIV3DAIUSDC in Maker). However, Compound does not have a stablecoin product. What are the potential use cases for go-to-market? What kind of demand do you see for this type of market structure?
- Partnership vs. Custom Implementation
- There are a few other active liquidity management solutions (e.g. Arrakis v2) that have been around for a while, and they’re proven in terms of contract implementation and experience with automated infrastructure. What are the trade-offs between partnering with existing solutions versus developing a custom implementation?
- Rebalancing Strategy
- How does the rebalancing strategy compare to similar solutions such as G-UNI, Gamma vault, ICHI vaults, etc? What’s the plan for optimizing the rebalancing parameters?
- Orchestration Infrastructure
- How will the rebalancing be orchestrated? What automation infrastructure is planned for this purpose?
- Asset Correlation Structure
- The asset correlation structure can change significantly based on the positions, especially for volatile asset-stablecoin pair, so the parameters need to be conservative. Do you have a specific methodology in mind for setting the parameters? What are your thoughts on the market risk implications?”
In summary, enabling Uniswap v3 LP tokens as collateral comes with several challenges. Addressing the key questions outlined would be critical to move the project forward.