Tackling Loss-Versus-Rebalancing (LVR)

Introduction to LVR

Liquidity providing is a cornerstone of decentralized finance (DeFi), but it’s accompanied by challenges like Loss-Versus-Rebalancing (LVR). Despite its significant impact, many liquidity providers (LPs) remain unaware of LVR, a complex form of maximal extractable value (MEV) that can erode profitability.

Origin of LVR
The concept of LVR was first introduced by a research team from Columbia University. They identified it as a form of arbitrage that arises when there’s a price discrepancy between a Constant Function Automated Market Maker (CF-AMMs) and other trading venues (CEXs). Arbitrageurs exploit these discrepancies, leading to a gradual depletion of value from liquidity pools.

The Magnitude of the Problem

LVR poses a substantial threat in the DeFi landscape, often resulting in losses for LPs that surpass their fee-based earnings. Research indicates that LVR can drain 5–7% of a pool’s liquidity annually, translating to hundreds of millions of dollars in losses. When factoring in LVR, many prominent liquidity pools reveal themselves to be unprofitable for LPs.

Calculating LVR
The formula to determine LVR is:

                           LVR = a(p - q)

Where:
a is the quantity of the asset being traded,
p is the prevailing market price (the “real” price), and
q is the price offered by the AMM (the “stale” price).

Research also suggested that higher asset volatility amplifies LVR, making it a persistent concern in dynamic markets.

Dextr’s Innovative Approach to Mitigating LVR

At Dextr, we’ve recognized the challenges posed by LVR and have integrated advanced features to safeguard our liquidity providers:

1. Price Source Selection
   Dextr allows LPs to anchor their liquidity based on real-time price feeds sourced from reliable oracles and or centralized exchanges (CEX). This flexibility ensures that LPs can align their liquidity offerings with the most accurate market prices, minimizing the risk of price discrepancies that arbitrageurs typically exploit. By enabling LPs to choose their preferred price sources, Dextr ensures they capture the maximum value from their liquidity positions.
2. Single-Sided Liquidity Positions
   Traditional AMMs often mandate LPs to provide liquidity in asset pairs, requiring equal value deposits of two different tokens. Dextr revolutionizes this model by facilitating single-sided liquidity provision. For instance, an LP can use 1 ETH to supply liquidity across multiple pairs like ETH/USDC, ETH/BTC, and BTC/USDT without needing to deposit the corresponding assets. This approach not only simplifies the liquidity provision process but also reduces exposure to complex mathematical curves.
3. Economic Guarantees
   Dextr will integrate Eigen Layer and employ dedicated operators who oversee off-chain order matching between traders and LPs. This vigilant oversight guarantees transparency and fairness in trade executions. In the rare event of proven front-running, users are automatically compensated from an insurance pool.

Conclusion

LVR presents a formidable challenge for liquidity providers, often leading to significant, albeit unnoticed, losses. However, with Dextr’s innovative strategies — ranging from customizable price sourcing and simplified liquidity provision to robust economic guarantees — LPs are better equipped to navigate the DeFi landscape securely and profitably.

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