Overview
In my first post, I summarized our Polygon POL experiment and shared the data we collected regarding established ranges, methodology, performance, fees earned, and our general conclusions. You can read Protocol-Owned Liquidity (POL) Analysis | Uniswap V3 [Polygon] | Part 1 to better understand the review included below.
In this post, I’ll summarize Part 2—POL management protocols, potential strategies
I’ll begin with a review of Arrakis Finance and continue with the broad considerations and recommended next steps for PoolTogether’s POL strategy going forward in Part 3.
Part 2: POL management protocols, potential strategies
Arrakis Finance
Arrakis is a liquidity management protocol built on top of Uniswap V3. With Arrakis, a project or individual can create a vault that allows liquidity to be managed in an automated way on a concentrated liquidity DEX (i.e., Uni V3). The “vault” is a Uniswap V3 position–an ERC-721 (NFT)–that is fractionalized and represented by ERC-20 tokens for those who deposit into the vault. This feature allows projects and users to provide liquidity through Arrakis and enjoy a user experience that mirrors that of depositing into a Uniswap V2 pool.
A vault has a manager who can rebalance the position, which entails adjusting the range, to ensure liquidity is provided within a defined, concentrated range. Providing liquidity in a concentrated range allows for greater depth with less total TVL—this is the value proposition of Uniswap V3. Arrakis allows you to rebalance a position, so you can keep concentrated liquidity in the active trading range (i.e., “in range”). Concentrated price ranges see a greater share of fees as people swap through the pool. Managers who rebalance and keep positions in range can potentially minimize the impact of divergence loss–more commonly known as “impermant loss.” Of course, this is dependent on manager’s performance when they adjust the in-range liquidity.
Arrakis V1 Vaults
With their V1 vaults, Arrakis allows anyone to create a vault, act as a manager, deploy strategies, and allow others to deposit into the vault.
A V1 vault allows you to create a ERC-20 wrapper for a Uni V3 position. This allows anyone depositing into the vault to receive an ERC-20 token that represents their share of the liquidity position. Because users receive ERC-20 tokens, you can still use traditional liquidity mining approaches.
You’re able to deploy a vault, or many vaults, with any price range on a Uni V3 pair, and you can allow a manager role (i.e., a wallet address designated as manager) to control the LP position and re-range part of the position or the entire position. This functionality is non-custodial, as the Uni V3 position is held in a smart contract. A manager can only adjust the ranges and rebalance. Arrakis is non-custodial, so a manager can’t remove funds.
From the Arrakis docs:
The manager can specify the range that should be used, they can specify how to shift the liquidity of the vault around, in order to do this they simply specify the new price bounds, and also specify the amount they want to swap in order to rebalance the inventory so that more funds fit into the token ratio needed for the new position.
There is an option to make a vault entirely immutable, which means the range can never be adjusted or rebalanced, but this may defeat the purpose of using an Arrakis vault in the first place.
You can read the Use Cases section in their docs for information on how Arrakis can be used. However, if PoolTogether were to use Arrakis, the DAO would use it for Liquidity as a Service Strategies, with POOLers allowing the TWG, or a future Finance Team, to manage their liquidity.
Arrakis-managed vaults
You can also create a vault, which is managed by the Arrakis team. This vault is managed by a 3/6 multi-sig. That will change once Arrakis v2 is launched, as the management process will be fully automated and a multi-sig would only be used for interventions (i.e., a project requesting to remove their liquidity). From the TWG’s perspective, we don’t believe an Arrakis-managed position is the right approach for POL.
Arrakis V2 vault
No documentation is complete for the v2 vaults, as of yet. However, V2 vaults are quite similar to v1 vaults—they allow someone to deposit in an ERC-20 wrapped two-sided liquidity position. They would receive ERC-20 tokens that represent their portion of the LP.
In Arrakis V2, the following will change:
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Deposits are more gas efficient—just transfer tokens to the vault and the deposit into Uniswap V3 is handled under the hood by keepers.
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Vaults can be comprised of arbitrary number of LP positions on a certain token pair
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LP positions can be on any arbitrary fee tier for that token pair–that means you could simultaneously deploy liquidity to multiple tiers and it would all be handled in one vault token interface.
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When swapping during rebalancing actions, you are not limited to a single Uniswap V3 pool to source the liquidity for swap.
The upgrades coming in Arrakis v2 will create a more efficient, fluid experience for users. When Arrakis V2 launches and offers automated strategies that don’t require manual rebalancing, then this would also reduce multi-sig signers’ liability significantly and make this option more realistic.
Arrakis Conclusion
Using Arrakis allows us to create vaults where anyone–the treasury AND POOLers–can deposit POOL and WETH to a Uniswap V3 position. This experience is akin to Uniswap V2 and would be an accessible way to migrate LPs from v2 to v3. The ERC-20 tokens LPs would receive could be used in our existing liquidity mining contract, with some modifications; this would make any initial incentives fairly seamless to offer.
While there are benefits to using liquidity management solutions like Arrakis, there are also drawbacks and other considerations to take into account in addition to the counterparty and regulatory risk stated above.
Arrakis has been audited, but smart contract risk can never be reduced to zero. This solution also adds another layer of smart contract risk on top of Uniswap V3. However, the TWG doesn’t believe this is the ideal approach at this time given some of the risks involved.
Uniswap V3 without a liquidity management solution
If the PoolTogether community wants to pursue a POL strategy without also managing POOLers funds, then we could establish Uniswap V3 positions and provide liquidity directly. This approach would require less active management, as we can set ranges that accomplish different goals but all work toward establishing deeper liquidity. POOLers can always migrate their liquidity to Uniswap V3, where trades will likely route if POL is moved to Uniswap V3 anyways.
Setting up ranges is relatively simple, though we would have to initially set the ranges and deposit using a multi-sig on Ethereum mainnet. If the governor alpha contract supports ERC-721 tokens, then we could send the positions there after we establish the ranges and add liquidity. Sufficient testing should be done to ensure we’re still able to move those positions, should we decide to send them to the treasury contract. We can also explore sending the Uni v3 LPs to the Executive Team, who can custody them in a more secure multi-sig.
As noted in Part 1, Uniswap V3 is highly efficient and establishing liquidity in more concentrated bands allows for larger trades with less slippage. Growing a Uniswap V3 position over time will allow for larger trades and dampen volatility. Right now, low 5-figure trades can substantially move the price of POOL in either direction. This causes extreme volatility, varies the value of the DAO treasury, and prevents community members from buying more POOL on the open market in order to be more active, influential in governance.
I’ll discuss the benefits of Uniswap V3 at length in Part 3. The following section will conclude Part 2 and share some of the considerations we should evaluate before any recommendation is offered.
Uniswap V3
Using Uni v3 without a liquidity management solution means that ranges would need to be set wider to require less manual intervention. This follows the approach the TWG took during our Uni v3 Polygon experiment. All of those positions are still in-range and earning fees. In-range positions create depth for anyone to trade between POOL and WETH.
Wider positions won’t capture as much in fees as concentrated positions if/when others provide liquidity into the pool in tighter price ranges. With wider ranges, we lessen the risk of divergence loss. This is applicable if we evaluate POL positions in USD terms. More concentrated positions introduce the potential of diversifying out of WETH and buying a significant amount of POOL at lower ETH prices, should the price drop and a range become 100% POOL. Should POOL price increase significantly, then we’d sell a significant amount of POOL at lower ETH prices and have 100% WETH.
By not using a liquidity management solution, we remove one layer of smart contract risk (i.e., less composability risk). However, there is still a non-zero chance of Uniswap V3 suffering an exploit.
Part 2: Conclusion
It’s clear that a POL strategy would bring significant benefits to the DAO and to POOLers at large. Both Arrakis and Uniswap V3 alone offer different pros and cons. In Part 3, I’ll review POL considerations and next steps.
You can find Part 3: POL considerations and next steps here.
You can find Part 1: Protocol-Owned Liquidity (POL) Analysis | Uniswap V3 [Polygon] here.