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Earning as a Liquidity Provider on Lynx
In this section, we examine the role of liquidity providers on Lynx. To see a tutorial on How to Deposit/Withdraw Liquidity, see:
Liquidity providers (LPs) play a key role on Lynx by funding the pools that users trade against, with deeper liquidity supporting higher trading volumes on the platform. LPs are therefore compensated by earning a portion of the platform's trading fees.
LPs can deposit into any of Lynx's single-asset liquidity pools to earn the fees generated by that pool without experiencing any impermanent loss. Depositing into single-asset pools provides tailored exposure to the specific asset deposited rather than broad exposure to a multi-asset basket.
Fees are earned in the same asset that was deposited. For example, depositing USDC into the USDC pool returns fees generated in USDC.
Note: We use the ticker TKN as a generic symbol to represent any ERC-20 token.
After providing liquidity to one of Lynx's liquidity pools, the pool will mint and credit the depositor's wallet with lxTKN (receipt tokens). lxTKN represents a liquidity provider's share of the pool to which they deposited. LPs receive lxTKN according to the specific liquidity pool they deposited into (eg. Deposit into the DAI pool and receive lxDAI).
The mechanism for minting lxTKN is based on 1-hour epochs. Upon depositing your assets, your desired lxTKN will be minted and received starting at the end of the following epoch. Depending on when you enter the current epoch, this can occur between 1 and 2 hours later.
After depositing TKN, a user's lxTKN will be minted and distributed to them starting at the end of the following epoch
The amount of lxTKN depositors receive is determined by the exchange rate at the time of minting, not at the time of deposit. For example, if an LP deposits 10 DAI when the exchange rate is 1.00 lxDAI/DAI and the exchange rate then increases to 1.50 lxDAI/DAI just before the lxDAI is minted, a liquidity provider would receive 15 lxDAI (1.50 lxDAI for every 1 DAI they deposited).
Similar to minting lxTKN, the system for redeeming lxTKN is based on 1-hour epochs. When you submit a request to redeem lxTKN, it will be exchanged back to the underlying TKN and dispersed to you starting at the end of the following epoch. Depending on when in the epoch you request to redeem, you will receive your underlying assets back between 1 and 2 hours later.
After redeeming lxTKN, underlying TKN is returned starting at the end of the following Epoch. Fees and PnL stop being absorbed immediately upon redeeming lxTKN.
When LPs redeem lxTKN, they receive back the underlying TKN according to the pool's exchange rate at the time of redemption, not at the time the request was made. For example, if an LP requests to redeem 10 lxDAI when the exchange rate is 1.50 lxDAI/DAI and the exchange rate then decreases to 1.00 lxDAI/DAI just before the lxDAI is redeemed, a liquidity provider would receive back 10 DAI (every 1.00 lxDAI exchanged for 1 DAI).
Note: When requesting to redeem, users set a slippage tolerance. Should the exchange rate change more than the specified slippage tolerance, the redemption transaction would be canceled and the receipt tokens returned to the user.
Each liquidity pool possesses an exchange rate that determines the current value of its lxTKN. The exchange rate for lxTKN is calculated by dividing the amount of TKN belonging to the specific pool by the amount of lxTKN minted for that pool. For example, assume 115,000 DAI belongs to the DAI pool and a total supply of 100,000 lxDAI has been minted. The lxDAI exchange rate would be 1.15 (ie. every 1.00 lxDAI is worth 1.15 DAI).
To determine the amount of TKN belonging to the pool, the system must take into account both the TKN sitting in the pool at that time but also the pool's unrealized PnL: the potential changes the pool would incur if all open positions were closed at once. This unrealized PnL can be a net positive value (traders owe the pool) or a net negative value (the pool owes the traders). Note: While a pool's unrealized PnL can be negative, Lynx's use of protocol safeguards prevents the amount of TKN belonging to the pool from ever being negative. This ensures every pool stays solvent, even under extreme market conditions.
Every epoch advancement, the system calculates the unrealized-PnL for each pool to determine its outstanding inflows and outflows and calculate the true amount of TKN belonging to it; the lxTKN exchange rate for that pool is then updated accordingly. At these epoch changes, the exchange rate is highly accurate and the system can process lxTKN minting and redemption requests using the fairest exchange rate.
LPs should consider the following economic and technological risks:
- Smart Contract Vulnerabilities
- Temporary Liquidity Crunches: In times of high pool utilization, LPs may have to wait a bit before being able to withdraw; during these times, LPs earn high interest from traders (see Protocol Safeguards)