Decentralized trading service GammaSwap launched today on the Arbitrum network in a move that developers say could benefit liquidity providers on the popular blockchain by providing a way to protect against what’s known as impermanent loss.
GammaSwap allows decentralized finance (DeFi) liquidity provider (LP) users to borrow tokens from automated market makers (AMMs) and short them, hedge against supplied collateral or create low-risk trading strategies. Shorting is a strategy to profit from a decline in the price of an asset.
Automated market makers are blockchain-based trading mechanisms that group assets into a so-called pool and establish a trading ratio based on the balance between supply and demand. A liquidity provider – someone who delivers assets to the pool in exchange for a reward – takes the risk that the ratio will change, resulting in a temporary loss (IL).
Transient loss occurs when the pool returns to equilibrium. As the prices of the tokens in the pool deviate from their starting ratio, the liquidity provider’s position loses value. The higher the volatility, i.e. the more the ratio between the prices of the tokens diverges, the more the LP loses and the more likely they are to earn a negative return. The loss is impermanent because it is erased when the ratio returns to its starting position.
Because market volatility and LP gains are inversely related, liquidity providers essentially “short” volatility, that is, they make profits when volatility is low and lose money when volatility is high. That is what GammaSwap wants to address.
GammaSwap allows traders to ‘go long’ volatility, rather than shorting it, by effectively ‘shorting’ LP tokens. It allows them to take the opposite stance to a liquidity provider and create an ephemeral profit instead of an ephemeral loss.
These features could help encourage more users to become liquidity providers, as it allows them to hedge against falling token prices, and should therefore increase liquidity in Arbitrum.
A GammaSwap representative told CoinDesk that the team plans to deploy more blockchains, such as BNB Chain and Ethereum, and provide support for Uniswap LPs – which lock billions of dollars worth of tokens across thousands of trading pairs.
UPDATE (September 20, 14:12 UTC): Adds the GammaSwap strategy mechanism in the fifth paragraph, usage in the seventh.