Concentric 102: Vault Design

A simple fact that everyone knows, but few people understand: LP’ing your tokens is easy, but doing it correctly is very difficult.  Anyone can make a deposit to Uniswap or Camelot, but without constant management, you’re actually leaving a ton of yield on the table.  What if we told you that with a better strategy, your APY could be double or even triple what you’re currently earning?

This is exactly why Concentric is introducing its flagship product: zero effort vaults for maximum LP yield.  Deposit your tokens into the protocol, set it, and forget it.

Recently, we posted on Mirror to introduce Concentric and describe some of the inner workings of the protocol.  Today, we’ll go over how the vaults themselves work, so you have a better understanding of protocol design. Let’s dig in.

Concentrated Liquidity: Pluses and Minuses

By now, most people are familiar with Uniswap’s concentrated liquidity model. Using their v3 model, you can choose a price range for a given token pair, and your LP position will only be active when price falls inside that range.  Parameters can be modified to balance yield against risk, but there’s a bit of strategy involved.

Consider: if you keep your position within a very narrow range, you receive higher fees for LP’ing.  If it’s too narrow though, you risk having the price move out of range.  Then you’re not earning anything at all.

Here we have the central value prop of Concentric: keeping your liquidity in a range as narrow as possible without losing money to downtime.

How is this accomplished?  Three primary mechanisms:

1. Optimizing LP Range: The vaults use an algorithm to determine the optimal range size for your token pair.  This way, you earn the highest yield possible when in range.

2. Allocating Liquidity: Given that volatility will inevitably drive the price out of range sometimes, the protocol divides your position into three separate ranges, calculating the most effective width and allocating the ideal percentage of liquidity to each.

3. Recentering and Rebalancing: On a periodic basis, the protocol recenters positions around the current spot price, making it less likely for the price to go out of range.

Now let’s take a look at each of these and go into a bit more detail on how they work.

Optimizing LP Range

At the heart of the vaults is an algorithm that calculates optimal range.  It’s designed to find the perfect middle ground for an LP position - narrow enough for high yield, but wide enough that the price stays in range.  There are a number of factors involved in this calculation, but the thing it leans most heavily on is implied volatility - the market’s forecast for how much price movement it expects within a given timeframe.

If you look at the chart above, you can see that the 1-day IV is listed at 31.75.  Implied Volatility is equal to one standard deviation, so we can infer that most of the time, the price of ETH will spend the next 24 hours within a 31.75% range.

You can see where this is going: if the market predicts a given range of price volatility, the algorithm uses this to deduce the appropriate range for a liquidity position.  In the future, ranges will be dynamically adjusted based on underlying volume, allowing them to narrow in anticipation of future changes in volatility.  For now, however, they are static, and provide a good approximation of likely price movement within a given timeframe.

Maximizing Uptime

So it’s great that IV is used to open a position more likely to stay in range, but obviously this can’t work all the time.  Prices are unpredictable.  For this reason, Concentric vaults actually open three separate ranges at the same time, and divide your liquidity between them.

In the same way that the narrowest range is determined by the implied volatility on a 1-day timeframe, two more ranges are constructed using the 7-day and 30-day IV.  This way, even when the price goes out of one range, it remains in at least one other.  All three of them are centered around the current spot price, with each successive range wider than the last.  Hence the name: Concentric.

Now, due to the design of the v3 model, narrower ranges receive a higher percentage of swap fees.  By definition, however, ranges constructed around higher time frames will be wider.  The vaults account for this by determining how much each range will receive based on its width, and allocating liquidity in a way that they all receive similar yield.  This has the added benefit of assigning more liquidity to the wider ranges, allowing the LP to capitalize on slippage from large trades.  This ratio is one more part of the calculations that go into maximizing return for liquidity providers.

Recentering and Rebalancing

While we can set our widths in such a way that price is statistically likely to stay in range, price action will inevitably leave any range over a long enough time period.  In any kind of trending environment, the price will simply not be in the same place indefinitely, and changes will need to be made.

This brings us to the final mechanism we’ll cover today: recentering and rebalancing.

With recentering, as the price moves in one direction or the other, the vaults will automatically update your position so the range is centered on the current spot price.  Say the price of ETH is at $1675, and the 1-day range for our LP trades between $1625 and $1725.  If the price goes up to $1715 the next day, your position is now $10 from exiting the range and leaving your capital stranded and non-productive.

For this reason, positions are periodically refreshed with the current spot price at the center.  In this case, liquidity would be withdrawn and redeposited with a range between $1665 to $1765 - equidistant from the current spot price of $1715.  Newly calibrated in this way, the position is once again unlikely to exit the range before its next recentering.

Finally, there is rebalancing.  Any LP position is made up of two tokens, and the ratio of each changes as a result of price movement.  As the price of one token goes up, your LP accumulates more of the other one, leaving the position with a disproportionate weight.

To recenter a position around the current spot price, however, requires the tokens to be weighted equally.  To achieve this, a swap is made to ensure you have the same amount of each asset.  This rebalancing, a necessary prerequisite to reopening your LP position, occurs at the same time as recentering.

This important thing to know about rebalancing and recentering is that both are a critical part of LP management, and it’s simply not possible to maintain a productive LP position without doing them.  These transactions are time-consuming, however, and they consume quite a bit of gas.  Recentering for the 1-day range currently occurs every six hours - for the average retail user, to perform these transactions with this level of frequency would almost certainly cancel out all of the yield they received from LP’ing in the first place.

One of the major benefits of the Concentric vaults is that by pooling all of these LP positions together, these recentering transactions are batched and cost a tiny fraction of the total yield.  In a sense, it’s like a buyers’ club for liquidity providers - an economy of scale that becomes efficient through the sheer number of users.  This alone makes the vaults a more realistic solution for most than LP’ing independently.

So we’ve explained the three mechanisms that underlie the Concentric vaults.  Now, to tie it all together, let’s see an example of what’s going on behind the scenes.

Example

Take the spot price of ETH.  Currently, it sits at $1675, and the implied volatility on a 1-day timeframe is 31.75.  7-day IV sits at 28.87, and 30-day at 30.89.

As discussed above, these IV figures are factored into the calculations to determine three range widths:

Range 1: 4%

Range 2: 9.5%

Range 3: 35%

These widths give you upper and lower bounds for each, centered around the current spot price.  In real terms, this means:

Range 1: 1607 - 1741

Range 2: 1515 - 1833

Range 3: 1088 - 2260

Finally, because the v3 model pays more or less depending on how narrow your range is, different amounts must be allocated to each range.  Based on the vault’s calculations, these weightings are:

Range 1: 15%

Range 2: 37%

Range 3: 48%

Voila: three ranges calculated to bring in maximum yield with the maximum amount of uptime, with liquidity distributed to each in proportion to its size.

Remember, this is one example based on the current spot price and the IV figures for three different timeframes.  These numbers will all change though, and the range sizes will change with them.  As they do, the vaults will update the ranges, all while continuing to recenter and rebalance your position, saving you time and gas fees, and maximizing yield.

Conclusion

Hopefully this helped to explain exactly what’s going on under the hood with the new Concentric vaults.  LP’ing is one of the cornerstones of DeFi, and we want to make it profitable and accessible for all users.  We look forward to doing just that when the vaults launch in early October.

In the meantime, feel free to reach out with any questions or thoughts - we would love to hear your feedback!

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