Automated market maker (AMM) platforms like Uniswap, and now Sovryn, are fundamental to the decentralized finance (DeFi) ecosystem. Sovryn has waved goodbye to the likes of centralized entities that traditionally provide (and profit from) market-making activities, opting instead for AMM technologies. However, this creates a need for liquidity to facilitate fast trades and swaps; Sovryn overcomes this by allowing anybody to become a liquidity provider. This means that anybody can supply tokens to any active pool to be used by the AMM to fulfill trades and swaps.
The decentralization of market-making enables trades and swaps to be trustless and creates countless possibilities for regular users to earn from their funds. Market making in an AMM allows Sovryn to channel profits that would typically flow exclusively to large centralized entities directly to its users. In return for users’ market-making liquidity, the AMM distributes fees generated from every trade in the pool to its liquidity providers. When users provide liquidity to an AMM pool, they are sent a new token(s) in return that acts as a receipt of their provision and a representation of their share of the liquidity in the pool. These Liquidity Provider (LP) tokens are used to allocate fee and liquidity mining (LM) rewards accurately, proportional to the user’s share of the pool.
For example, if you were to supply $100 worth of funds to a Sovryn pool that has a total value of $1,000, you would receive 10% of that pool’s LP tokens because you own 10% of the liquidity within the pool. The LP tokens become the receipt of your portion of the pool’s funds. You hold these LP tokens in your own wallet and have total control over when you redeem them to withdraw your share of the pool. Theoretically, since Sovryn LP tokens are ERC-20s, they can be transferred, exchanged, and potentially staked, even on other protocols.
It’s important to remember that the LP tokens received are not on a 1:1 ratio with the tokens that users provide. For example, if a user-provided 10 SOV to a pool, they would not receive 10 LP tokens - the amount of total LP tokens within a pool is dynamic and are not set 1:1 with either of the assets within the pool. A user can receive any amount of LP tokens depending on the pool, so if a user-provided 10 SOV they may receive, for example 2 LP tokens. This doesn’t mean that the user has lost 8 SOV, it is just that LP tokens are not proportionally denominated with any asset in the pool. In this scenario, the user could redeem their 2 LP tokens and withdraw 10 SOV. The AMM records how many LP tokens it has created and given in return for liquidity. When a new user provides liquidity the AMM creates more LP tokens and gives the user the appropriate amount which would maintain accurate relative shares of the pool for both previous and new LPs.
LP tokens allow AMMs to be non-custodial, meaning they do not hold on to your tokens. When you provide your funds to the Sovryn AMM, you interact only with a smart contract, which is under the collective control of the Bitocracy. The AMM operates solely via automated functions that can only ever be changed if a proposal to change it were to pass through Bitocracy voting. The AMM is programmatically bound to execute users’ transactions to supply and withdraw funds, and is hard-coded to provide and pay for the distribution and redemption of LP tokens.
Liquidity is a crucial concept in DeFi. The term denotes how easily one asset can be converted to another. Cash has traditionally been the most liquid asset because it can easily be exchanged for gold, bonds, stocks and other assets. Already, cash is becoming easier and easier to convert to and from crypto. In the wider crypto environment, bitcoin is the most liquid asset because it is tradeable and accepted almost everywhere. The current DeFi ecosystem is almost exclusively built on the Ethereum network and therefore Ethereum’s native token, ether, is the most liquid asset. Ether is also accepted and tradeable on almost every centralized and decentralized exchange. Now, Sovryn combines these concepts, introducing the most liquid and secure asset in the crypto space (bitcoin) to DeFi.
DeFi is growing exponentially and the terms defining the space are constantly developing. What Sovryn refers to as LP tokens may be referred to by different names depending on the platform. For example, Balancer has balancer pool tokens (BPT) and Uniswap LP tokens are referred to simply as pool tokens or liquidity tokens. Though the names for LP tokens can be different, the meaning is the same. LP tokens are proof that user-provided assets to a pool, and can be used in any solution that requires knowing a user’s share of a pool (such as liquidity mining). These LP tokens can be redeemed at any time for the share of the pool assets they represent.
One emerging product of DeFi is yield farming. The idea behind yield farming is that LP tokens can be used as an asset in and of itself. The LP tokens users receive from providing liquidity represent a share of the liquidity in a pool; as such, they can be seen to hold the same tradeable value as the original share of liquidity provided. Therefore, LP tokens *could* be staked to earn value, additional to the fee and LM rewards, that their represented share is earning in the pool.
One live example of this is farming the CRV token on the Curve protocol using DAI, see the steps involved below:
· A user deposits DAI to Curve’s crypto liquidity pool
· They receive LP tokens in return for their liquidity
· The user then stakes these LP tokens in the Curve staking pool
· The user receives CRV token rewards for their stake
In this scenario, the user’s DAI is earning from fees in Curve’s liquidity pool. Simultaneously, the staked LP tokens from the liquidity pool are earning CRV token rewards. By using LP tokens, users can earn more from their funds. At the time of writing, Sovryn facilitates liquidity providing, granting fee, and liquidity mining rewards based on users’ LP tokens. There are no means to achieve the above example by staking Sovryn LP tokens… yet.