Overview
Automated market makers (AMMs) are the cornerstone of decentralized finance (DeFi). The ability to swap tokens via smart contracts, without human intervention, is a key innovation of DeFi. In order to function, AMMs rely on liquidity providers (LPs) to supply pools with tokens. In return, the liquidity providers earn fees on the buy and sell transactions in the pool.
The introduction of concentrated liquidity via custom price ranges in the Uniswap v3 upgrade was designed to improve the capital efficiency of liquidity providers. Although improvements have been made for LPs, providing liquidity still remains a complex and time-consuming process. One must consider price ranges, fee tiers, and the risk of impermanent loss. Gamma Strategies is designed for this problem through non-custodial, automated, concentrated liquidity management services.
Challenges with Providing Liquidity
The introduction of concentrated liquidity pooling in Uniswap V3, Sushi trident, and other automated market-making platforms improved the capital efficiency for liquidity providers through custom price ranges. LPs can choose to pool their tokens in a certain range, effectively concentrating their liquidity. This optimized the trading fee generation for LPs, but it can also amplify the effects of impermanent loss. Impermanent loss occurs when the price of assets deposited in a liquidity pool changes relative to when the user originally deposited them. An LP could realize a loss if they withdraw their position at a lower dollar value than when they deposited.
Given crypto volatility, LPs should monitor their positions to effectively manage yield generation and mitigate risk. They must assess the upper and lower bands of their concentrated liquidity position. Naturally, this is complex and time-consuming.
Gamma Strategies
Active liquidity management (ALM) are strategies that actively adjust the liquidity parameters on behalf of the LP. As an ALM program, Gamma’s smart contracts automatically manage the prices ranges, rebalances assets, and reinvest the fees earns for optimal yields.
How Gamma Works
Gamma is built with modular components consisting of a Uniswap position manager contract called a hypervisor, which contains a set of functions that are able to be called by an active manager or Supervisor contract. The hypervisor functions include rebalancing ranges, depositing liquidity, collecting and re-investing fees, and redeeming LP tokens for the underlying assets. When the user deposits their token into a hypervisor, a fungible ERC-20 liquidity provider token is minted, which represents their fractional ownership of the pool. If they want to withdraw tokens from the pool, the LP token is burned. The hypervisor structure allows for multiple parties to pool their tokens into a single actively-managed position.
One challenge with directly providing liquidity on some AMMs like Uniswap is that they require an exact 50/50 pair of two tokens. The hypervisor structure allows for LPs to deposit dual-sided token combinations that are not precisely in 50/50 proportions. This is achieved through an innovative base and limit position structure. The base position matches the pool’s ratio of tokens, while the limit position contains a single asset. Ultimately, the hypervisor performs functions on behalf of the LPs, such as setting position ranges, rebalancing, collecting and reinvesting the fees earned.
The supervisor contract then employs the asset management strategy for the hypervisor. The supervisor periodically calls the rebalance function to adjust the LP position on the AMM. The rebalance function is a crucial part of the process because it’s where the impermanent loss of the position is realized. In the future, it will be important to backtest the performance of Gamma strategies (with fees generated) from an impermanent loss perspective.
Public and Enterprise Solutions
In addition to providing liquidity management solutions for the general public, Gamma has introduced an enterprise solution for DAOs and other projects. These features include liquidity mining, sustainable treasury grants, and co-managed liquidity (co-supervisor).
In Gamma’s view, if protocols and DAOs can incentivize liquidity on concentrated management platforms (like Gamma), less liquidity will be required for capital efficiency. As a result, fewer liquidity incentives will be required. This is strategically important for most protocols, as liquidity incentives can become a death spiral for the native token.
Many projects establish grants programs to incentivize contributors. Sustainable treasury grants are derived from the yield generated on treasury assets, rather than withdrawing native tokens or stablecoin balances. Gamma gives projects the opportunity to generate yield on assets in their treasuries and to use this income for grants.
And lastly, many projects have begun protocol-controlled liquidity programs. Gamma offers a co-managed solution for such programs.
With only $13 million in total value locked, it appears that not many projects have utilized Gamma’s enterprise management platform. Going forward, this could be the primary driver of Gamma’s growth. Many DAOs and protocols have amassed large treasuries. And liquidity management has remained an “unsolved” challenge. For the general public, an actively managed liquidity solution might be too complex or uninteresting.
Gamma’s Position Management
How does Gamma manage the ranges for liquidity positions? These strategies are core to Gamma’s value proposition. In their published materials, the team reviews some strategies at a high level, but does not provide details on which strategies are employed on specific pools.
According to Gamma, their strategies are based on backtesting of past prices and other time-series forecasting methods such as Bollinger bands, empirical probabilities, and machine learning algorithms. Currently, Gamma is employing an Autoregressive strategy based on mean reversion. In essence, a statistical model is used to dynamically set the center and width of the liquidity ranges depending on recent market behavior. By doing so, it uses the concept of mean reversion to predict where the price will go, further increasing the time spent in-range and mitigating impermanent loss.
Gamma has also introduced a $500,000 grants program to empower individuals from the community to develop their own active liquidity management strategies. In this way, Gamma could be a platform for new and experimental price prediction strategies.
Tokenomics of Gamma
GAMMA is the native token of Gamma strategies. The tokenomics of Gamma are relatively simple and the value accrual is straightforward. Users that stake their GAMMA are rewarded with 10% of the fees across all liquidity pools on Gamma. The hypervisor contract automatically takes a 10% portion of the fees. As a result, the Gamma token allows the user to benefit from liquidity pool profits, without needing to directly provide liquidity. The Gamma team has introduced a staking mechanism for GAMMA through xGAMMA. The fees are accrued when the pools rebalance and the 10% share goes to GAMMA stakers. xGAMMA represents the staked GAMMA token. Currently, the GAMMA token does not have governance rights or specific liquidity mining rewards. The team has suggested these features might be added in the future.
The total supply of the GAMMA token is 100,000,000 with about 33% in circulation and 66% not in circulation. The GAMMA tokens were distributed to the following parties and use-cases below.
Our View
Gamma is an impressive solution to a fundamental problem in the decentralized financial service industry. With only $13 million in total value locked, but over $7 million in fees generated, it is clearly an underutilized solution in the ecosystem. The protocol estimates approximately a 21% aggregated fee-based APR on their actively managed liquidity pools. These are impressive numbers for market-making activities.
Gamma represents an ecosystem layer of liquidity management in DeFi. This is extremely compelling because token liquidity and the incentives death-spiral remain a fundamental problem for DAOs and protocols across DeFi. Given the complexity and risk-return profile of liquidity providing, individual users are not always the best audience for active liquidity management solutions. For this reason, we believe that Gamma’s highest opportunity for growth will be through projects (B2B over B2C). And this growth could be significant.
While Uniswap is the dominant AMM in DeFi, with roughly 80% market share across Ethereum-native decentralized exchanges, Gamma should expand. The team has an ambitious roadmap, including incorporating other chains like Polygon (already launched), Optimism, and Arbitrum. In addition, the team has announced partnerships with other projects such as Tokemak, Olympus Pro, and KeeperDAO.
The team has also teased “Gamma Pro,” which is a broader suite of market-making infrastructure for DeFi projects. We’ll certainly be waiting to learn more about this product when it launches.
To put it simply, keep an eye on Gamma; it's an impressive solution to an integral problem in DeFi.
Sources and additional reading
Gamma Strategies documents - https://docs.gammastrategies.org/gamma/
ETH Global Presentation (November 2021) - https://www.youtube.com/watch?v=Fay4FChHsWQ
Additional reading on Impermanent loss from Consensys - https://consensys.io/blog/impermanent-loss-defi-markets-gotcha-number-two
Challenges with Liquidity Providing and the benefits of Active Liquidity Management by 0xKydo - https://kydo.substack.com/p/palm-protocol-owned-active-liquidity?utm_source=url&s=r
Strategic Liquidity Provision in Uniswap V3 (Harvard Researchers) - https://arxiv.org/pdf/2106.12033.pdf
AMM Market Share via Delphi - https://members.delphidigital.io/reports/uni-market-share-shines-stablecoins-wars-fresh-farms/
Gamma Roadmap announcement (Feb 2022) - https://medium.com/gamma-strategies/gammas-immediate-road-map-audits-strategies-liquidity-venues-and-market-making-c81db904d7a0
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