Cover: A New Saga for AMM Protocols

Introducing Cover

Directional liquidity was introduced in January of this year by Poolshark 🦈 in order for LPs to have a means of taking directional trades against the market.

Our thesis is that the ways in which users can provide liquidity to decentralized exchanges is limited in the current market.

Enter Cover: a stop-loss liquidity pool.

Today the Poolshark team is proud to publicize the smart contracts for Cover, a fully on-chain liquidity protocol allowing users to hedge against market movement.

Cover Position vs. Simulating Cover with Multiple Swaps
Cover Position vs. Simulating Cover with Multiple Swaps

Cover is not just about decentralizing stop-losses in a meaningful way, but also about opening up the minds of builders around the world in thinking about how to shift the paradigm of AMMs into a new era.

The ultimate dream for on-chain enthusiasts is to have all the features that centralized exchanges offer today but on-chain with intuitive UX, fine-tuned controls, and most importantly, full self-custody.

Continuous Liquidity vs. Profitability

The transition to range-bound or concentrated liquidity has been a significant development in the DeFi world, with several projects moving towards this new liquidity model and paradigm for on-chain protocols.

Providing liquidity within a set range increases capital-efficiency and thus fee revenue earned by liquidity providers. In the same way, impermanent loss risk also increases due to more liquidity being available near market price.

Today’s AMMs work quite well for highly-correlated assets such as stablecoin pairs and liquid staking derivatives (LSDs) and have been proven to be profitable ventures in a large number of cases. According to Impermanent Loss and Price Discovery by Jonathan Choong “this profitability does not apply to riskier asset pairs, which saw average negative returns of -20%” (Choong 57).

Ultimately when providing liquidity, LPs open themselves up to taking a trade on either side of the pair in exchange for trading fees. Liquidity providers are exposed to volatility and agree to take on the payoff profile of both the trading fees as well as the resulting impermanent loss (IL).

Directional AMMs vs Bidirectional AMMs
Directional AMMs vs Bidirectional AMMs

Impermanent Loss is ultimately the difference between the average price LPs sell their position at versus the current liquid value had the LP held those same assets.

Instead of limiting trading volume by attempting to shut down Impermanent Loss from happening in the first place, Cover allows self-custody liquidity providers to hedge against volatility and generate a profit margin as the market moves in their favor.

This profit margin is intended to offset the impermanent loss a liquidity provider would experience over that same range. Thus, they are able to minimize the costs of rebalancing their liquidity position.

Cover Pools as a Stop-Loss

Cover supports stop-loss and range stop-loss orders for traders. In trading, a stop-loss order is a common tool used to automatically close a trade when a pre-set price is reached.

This helps protect the trader's capital and minimize risks. Some benefits of using a stop-loss in trading include:

  • Protection against further risk to capital in volatile markets

  • Safeguarding profits on held assets or profitable active trades

  • Protection from liquidation when lending or accessing leverage

Cover positions unlock liquidity as price crosses a user's range.
Cover positions unlock liquidity as price crosses a user's range.

Mirroring the market

One way to use a stop-loss order to move with the market is by employing a trailing stop-loss order. A trailing stop-loss order is an order that executes when the price of an asset moves a percentage or dollar amount in a specified direction.

As the price of the stock moves in the investor's favor, the trailing stop-loss order rises along with it, but it doesn't move if the price moves against the trader. This allows the investor to automatically ride trends that are in their favor while exiting when a reversal sets in.

Covering Impermanent Loss

If in the pair of tokenA to tokenB one side begins to drop in value you increase your exposure to the side dropping in value. On the contrary if token A increases in value the position accumulates a greater proportion of token B. This may seem like a losing battle without a lot of liquid ways to hedge.

One way to hedge against impermanent loss is by using stop-losses, which involve setting a specific price at which you will sell your assets to minimize losses. This essentially acts in reverse to by gaining exposure to the side increasing in value.

Today’s AMMs are short volatility.

Cover longs volatility in the same direction as the market.

Whitelisted Testnet

Currently, Poolshark is conducting its Beta Testnet Phase 1, where users can participate in giving feedback on the UI and help be apart of the journey to mainnet.

Join our Discord to find out how to participate in future Beta Testnet Phases.

Minting a Cover LP using the Beta Phase 1 UI.
Minting a Cover LP using the Beta Phase 1 UI.

What’s up Next

Poolshark is targeting an Arbitrum Mainnet launch after Beta Testnet Phase 3. From there, we will be diligently branching out onto other networks that we align with from a technology and UX perspective.

The Poolshark Team feels we have a responsibility to signal to users where we believe the innovation will occur in the future and thus will be laser-focusing our efforts onto networks that align with our vision of decentralization and expanding network effects.

As decentralized technology continues to flourish and scale to millions of new users, we’re excited to be a critical part of that path to mainstream adoption with self-custody trading experiences that users know and love.

Thank you to everyone for all the support in building this public good that we hope will empower users to exchange their assets in ways they never imagined possible.

Stay vigilant,

Poolshark Team 🦈

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