Maximizing Returns: A Guide to Risk and Yield Calculations in Resolv Spectra Pool
Oct 31, 2024
The recently launched Resolv Spectra wstUSR/PT-wstUSR pool offers a compelling alternative for AMM liquidity providers, delivering attractive 13% native yield and 42% with rewards. However, evaluating potential impermanent loss (IL) for these pools can be complex. We performed a detailed analysis to evaluate the risk and establish the optimal points allocation needed to offset IL.
Summary: IL is influenced by interest rate volatility and usually occurs with significant liquidity-draining swaps (e.g., 30%). Even then, the loss remains manageable, capped at around 1.5%.
Deploying liquidity in the wstUSR pool, new LPs can also enjoy a 20% points bonus as part of Resolv’s welcome campaign, making it one of the highest native-yield stablecoin pools available.
What Are Principal Tokens (PT) and Yield Tokens (YT)?
When an asset is tokenized, it’s split into two components:
Principal Token (PT): PT represents the original value of the asset, or the “principal” that you will get back at maturity. Holding PT ensures that at the end of the term, you receive the initial amount invested.
Yield Token (YT): YT is linked to the asset’s future interest, or “yield.” Holding YT entitles you to receive the interest generated over time.
The price of PT is influenced by interest rates. Early in its life, PT typically trades below its face value of 1, reflecting the market’s expectation of the asset’s yield. As maturity nears, PT’s price converges to 1, or the full principal value, similar to how zero-coupon bonds work.
Mechanics of Yield Trading
When you buy Principal Tokens (PT), you’re securing the original value of the asset, effectively insulating yourself from fluctuations in future interest rates. This can be seen as taking a “short” position on interest rates — if rates fall, the value of PT increases, as you’ve locked in the principal at a lower initial cost.
Conversely, buying Yield Tokens (YT) is a bet on future interest generation. If you expect rates to rise, purchasing YT allows you to capitalize on higher future yields, making it akin to going “long” on interest rates.
From a technical perspective, when users buy YT, they are essentially selling PT in exchange for the original asset. This is why trading yield is essentially trading PT against the base asset, typically facilitated by automated market makers (AMMs).
Example of the wstUSR/PT-wstUSR Spectra Pool
Spectra is a permissionless platform for interest rate trading, enabling users to participate in fixed-rate and leveraged yield farming.
Spectra leverages Curve v2 AMMs (also known as Cryptoswap) to create markets for yield trading. Cryptoswap is particularly well-suited for trading soft-pegged assets, such as base assets and their Principal Tokens (PT). We won’t go into the technical details of how AMMs work but will highlight that Cryptoswap facilitates efficient trading between these closely related assets.
The figure below illustrates the price curve for the real wstUSR/PT-wstUSR pool, showing the relationship between wstUSR and PT-wstUSR prices. At the time of writing, the pool holds approximately $113k in liquidity.
How to Think About the Pool
The price curve of the pool behaves almost linearly around its equilibrium point (x₀, y₀), which is designed to offer optimal slippage protection for traders interacting with the pool.
However, this slippage protection comes with the risk of impermanent loss (IL) for liquidity providers (LPs). As long as swaps remain within the linear region, impermanent loss is minimal. In more extreme cases, where swaps push the price beyond this linear range, LPs are more likely to experience significant IL. Managing this trade-off is key to understanding the risk profile of the pool.
Simple Model for Impermanent Loss
Calculating exact impermanent loss for such bonding curve is a challenge. Instead, let’s use a conservative yet practical approximation. For this purpose, a constant-sum bonding curve (green dotted line) will be a very good choice. It has a very simple formula:
In this model, impermanent loss will come from the difference between P — the price assumed for your trades and P’ — actual market price right after the trade.
Consider an example: P=0.5$, you hold 1 PT and 1 wstUSR as an LP.
If someone buys 1 PT token at P, your balance will be 1 wstUSR.
There is no loss in the sense of value of the position as compared to initial state. However, at the same time, the liquidity provider would be better off if they kept wstUSR and PT-wstUSR outside of the pool. They would have benefitted from the increase of the PT price without selling it at a lower price within the pool.
For liquidity providers, such impermanent loss vs static position may or may not be counterweighted by profits associated with utility function of the pool, such as harvesting trading fees and incentives from the protocols.
Approximating Impermanent Loss of wstUSR Pool
Imagine you are LPing into such pool $100.000. You evenly distribute between wstUSR and PT tokens. Let’s say current PT price is 0.831 which is 37.5% implied APY at 180 maturity.
Scenario A: someone buys large amount of PTs dropping the implied yield
If someone buys $20,000 worth of PTs, it will move the price by 8%.
In a moment, you as LP will realize an IL of 1.45%.
Scenario B: someone buys large amount of YTs increasing the implied yield
If someone sells $20,000 of PTs (through buy of YTs), due to symmetry, it will move the price again by 8% — but now in another direction.
In this scenario, in short term you realize a small impermanent loss of 1.52% because you now own more PTs that are valued at lower price.
How Resolv Points Reduce IL Exposure
Pools such as wstUSR/PT-wstUSR are not completely IL-free. We conservatively estimated it to be 1.5%. However, we used linear approximation to our actual bonding curve. This approximation allows to grasp intuition behind the pool easily but overestimates the IL. In reality it should be around 0.6–0.8%. Moreover, there is almost no impermanent loss if trading is done within dense liquidity region.
Not only fees will cover this loss, but also Resolv points! Resolv gives 30x/day points per $1 of liquidity — this one of the biggest rates.
How can one estimate points impact?
As of time of writing, wstUSR implied yield is ~40% for 114 days.
Average annual yield of wstUSR is expected to be around ~10%. Points expected APY is around 30%. Thus, points effective implied yield at maturity is around 9.36%.
wstUSR points rate is 5 points per day. Thus, you get 1.87% per 1 point.
LPs earn 30 points per day — thus, resulting in 56.1% APY
In total, Spectra wstUSR LPs could earn 24.99% (native yield from PT, wstUSR, and fees) + 56.1% Resolv points + 11% APW rewards = 92.11%. This amount would cover estimated IL by a lot!
The recently launched Resolv Spectra wstUSR/PT-wstUSR pool offers a compelling alternative for AMM liquidity providers, delivering attractive 13% native yield and 42% with rewards. However, evaluating potential impermanent loss (IL) for these pools can be complex. We performed a detailed analysis to evaluate the risk and establish the optimal points allocation needed to offset IL.
Summary: IL is influenced by interest rate volatility and usually occurs with significant liquidity-draining swaps (e.g., 30%). Even then, the loss remains manageable, capped at around 1.5%.
Deploying liquidity in the wstUSR pool, new LPs can also enjoy a 20% points bonus as part of Resolv’s welcome campaign, making it one of the highest native-yield stablecoin pools available.
What Are Principal Tokens (PT) and Yield Tokens (YT)?
When an asset is tokenized, it’s split into two components:
Principal Token (PT): PT represents the original value of the asset, or the “principal” that you will get back at maturity. Holding PT ensures that at the end of the term, you receive the initial amount invested.
Yield Token (YT): YT is linked to the asset’s future interest, or “yield.” Holding YT entitles you to receive the interest generated over time.
The price of PT is influenced by interest rates. Early in its life, PT typically trades below its face value of 1, reflecting the market’s expectation of the asset’s yield. As maturity nears, PT’s price converges to 1, or the full principal value, similar to how zero-coupon bonds work.
Mechanics of Yield Trading
When you buy Principal Tokens (PT), you’re securing the original value of the asset, effectively insulating yourself from fluctuations in future interest rates. This can be seen as taking a “short” position on interest rates — if rates fall, the value of PT increases, as you’ve locked in the principal at a lower initial cost.
Conversely, buying Yield Tokens (YT) is a bet on future interest generation. If you expect rates to rise, purchasing YT allows you to capitalize on higher future yields, making it akin to going “long” on interest rates.
From a technical perspective, when users buy YT, they are essentially selling PT in exchange for the original asset. This is why trading yield is essentially trading PT against the base asset, typically facilitated by automated market makers (AMMs).
Example of the wstUSR/PT-wstUSR Spectra Pool
Spectra is a permissionless platform for interest rate trading, enabling users to participate in fixed-rate and leveraged yield farming.
Spectra leverages Curve v2 AMMs (also known as Cryptoswap) to create markets for yield trading. Cryptoswap is particularly well-suited for trading soft-pegged assets, such as base assets and their Principal Tokens (PT). We won’t go into the technical details of how AMMs work but will highlight that Cryptoswap facilitates efficient trading between these closely related assets.
The figure below illustrates the price curve for the real wstUSR/PT-wstUSR pool, showing the relationship between wstUSR and PT-wstUSR prices. At the time of writing, the pool holds approximately $113k in liquidity.
How to Think About the Pool
The price curve of the pool behaves almost linearly around its equilibrium point (x₀, y₀), which is designed to offer optimal slippage protection for traders interacting with the pool.
However, this slippage protection comes with the risk of impermanent loss (IL) for liquidity providers (LPs). As long as swaps remain within the linear region, impermanent loss is minimal. In more extreme cases, where swaps push the price beyond this linear range, LPs are more likely to experience significant IL. Managing this trade-off is key to understanding the risk profile of the pool.
Simple Model for Impermanent Loss
Calculating exact impermanent loss for such bonding curve is a challenge. Instead, let’s use a conservative yet practical approximation. For this purpose, a constant-sum bonding curve (green dotted line) will be a very good choice. It has a very simple formula:
In this model, impermanent loss will come from the difference between P — the price assumed for your trades and P’ — actual market price right after the trade.
Consider an example: P=0.5$, you hold 1 PT and 1 wstUSR as an LP.
If someone buys 1 PT token at P, your balance will be 1 wstUSR.
There is no loss in the sense of value of the position as compared to initial state. However, at the same time, the liquidity provider would be better off if they kept wstUSR and PT-wstUSR outside of the pool. They would have benefitted from the increase of the PT price without selling it at a lower price within the pool.
For liquidity providers, such impermanent loss vs static position may or may not be counterweighted by profits associated with utility function of the pool, such as harvesting trading fees and incentives from the protocols.
Approximating Impermanent Loss of wstUSR Pool
Imagine you are LPing into such pool $100.000. You evenly distribute between wstUSR and PT tokens. Let’s say current PT price is 0.831 which is 37.5% implied APY at 180 maturity.
Scenario A: someone buys large amount of PTs dropping the implied yield
If someone buys $20,000 worth of PTs, it will move the price by 8%.
In a moment, you as LP will realize an IL of 1.45%.
Scenario B: someone buys large amount of YTs increasing the implied yield
If someone sells $20,000 of PTs (through buy of YTs), due to symmetry, it will move the price again by 8% — but now in another direction.
In this scenario, in short term you realize a small impermanent loss of 1.52% because you now own more PTs that are valued at lower price.
How Resolv Points Reduce IL Exposure
Pools such as wstUSR/PT-wstUSR are not completely IL-free. We conservatively estimated it to be 1.5%. However, we used linear approximation to our actual bonding curve. This approximation allows to grasp intuition behind the pool easily but overestimates the IL. In reality it should be around 0.6–0.8%. Moreover, there is almost no impermanent loss if trading is done within dense liquidity region.
Not only fees will cover this loss, but also Resolv points! Resolv gives 30x/day points per $1 of liquidity — this one of the biggest rates.
How can one estimate points impact?
As of time of writing, wstUSR implied yield is ~40% for 114 days.
Average annual yield of wstUSR is expected to be around ~10%. Points expected APY is around 30%. Thus, points effective implied yield at maturity is around 9.36%.
wstUSR points rate is 5 points per day. Thus, you get 1.87% per 1 point.
LPs earn 30 points per day — thus, resulting in 56.1% APY
In total, Spectra wstUSR LPs could earn 24.99% (native yield from PT, wstUSR, and fees) + 56.1% Resolv points + 11% APW rewards = 92.11%. This amount would cover estimated IL by a lot!