Liquidity Pools
Concentrated liquidity
In some DEXs such as Uniswap v2, liquidity is distributed evenly along an x*y=k price curve, with assets reserved for all prices between 0 and infinity. For most pools, a majority of this liquidity is never put to use. For example, an Uniswap v2 DAI/USDC pair reserves just ~0.50% of capital for trading between $0.99 and $1.01 , the price range in which LPs would expect to see the most volume and consequently earn the most fees.
When providing liquidity in the pools of those DEXs, LPs only earn fees on a small portion of their capital, which can fail to appropriately compensate for the price risk (impermanent loss) they take by holding large inventories in both tokens. Additionally, traders are often subject to high degrees of slippage as liquidity is spread thin across all price ranges.
However, with Skeleton, LPs can concentrate their capital within custom price ranges, providing greater amounts of liquidity at desired prices. In doing so, LPs construct individualized price curves that reflect their own preferences. In addition, liquidity providers can earn more trading fees with the same amount of capital.
Here is an example:
Harry and Sarah both provided liquidity in ETH/DAI pool with $1M USD worth of token assets. The current price of ETH is 1500 DAI.
Harry provided his liquidity across the entire price range. Therefore he deposited all of his capital, 500,000 DAI and 333.33 ETH (worth a total of $1m).
Sarah utilized the concentrated liquidity feature in Skeleton and created a position with a price range of 1.000 to 2.250 DAI per ETH . She deposits 91,751 DAI and 61.17 ETH , worth a total of about $183,500. She is now able to spend the remaining $816,500 elsewhere, like locking ETH in a pool to enjoy high ETH yield while receiving a series of Skeleton ecosystem benefits.
As long as ETH stays within the price range of 2 to 12.5, both Harry and Sarah will receive the same amount of trading fee rewards while Sarah deposited way less capital to the liquidity pool.
Active liquidity and price ranges
In Skeleton, liquidity providers can configure their positions to only provide liquidity when the price is within a certain range. If the trading price moves out of the range, the position will consist of only one type of token in the pair and become inactive.
Inactive liquidity positions will not participate in trading or earn any trading fees.
Earning trading fees
Providing liquidity gives you a reward in the form of trading fees when people use your liquidity pool to complete swaps.
Whenever someone trades on Skeleton, for each hop (swap) in each Skeleton liquidity pool, depending on the liquidity pool fee tier, the trader pays a fee ranging from 0.01% to 1%. Their fee rates and fee breakdowns are shown as follows:
Liquidity Provider
67%
66%
68%
68%
68%
68%
Protocol
33%
34%
32%
32%
32%
32%
For example, in a 0.25% fee tier pool:
Among all the active (in-range) liquidity positions, there are a total of 10 USDC and 10 FTM tokens.
Someone trades 1 USDC for 1 FTM.
Someone else trades 1 FTM for 1 USDC.
The liquidity providers who are in the range providing active liquidity earned a total of 0.0017 USDC and 0.0017 FTM from the trades.
Positions with price ranges that are not covering the current price, therefore being inactive, will not contribute to trading or earn any fees.
Impermanent Loss
Providing liquidity is not without risk, as you may be exposed to impermanent loss.
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