CompliFi: USDC Liquidity Provision Explained — How-to & Risks Involved.
*Note this guide is unofficial and not financial advice.
CompliFi takes DeFi by a storm. It’s still under the radars, but not for much longer.
As of writing this (May 25, 2022), CompliFi’s $USDC pool is now ranking on top of APY for stablecoins at reputable tracker defillama.
Web3 eyes are now pointing at the protocol no one has ever heard of.
USDC pool now reaching 7-day ~90% APY
In short, that APY is a combination of raw fees and active management of pool risk by CompliFi’s on-chain algo.
But where’s the catch? What are the risks involved? Where does that high APY really come from? How sustainable is it?
In this article, I’ll do my best to describe and explain the mechanics behind the $USDC Pool to answer these questions. I’ll talk about native ERC-20s pools some other time.
Grab yourself a cup of coffee as we’re taking a ride through some tech specs first.
Let me brief you about CompliFi.
It’s not a new protocol — its unique characteristics were outlined in this whitepaper written in early 2020. In short, it talks about how Uniswap Invariant can be leveraged to build a different AMM design that yields liquidity providers better returns.
The mechanism ended up powering what we know today as CompliFi, with the first version called simply ‘V1’ launched in mid-2020.
In short, CompliFi is a purely on-chain derivatives protocol offering unique trading conditions such as liquidation-free leveraged trading.
Yes, you heard that right. There are no liquidations on leveraged positions on CompliFi. Another interesting point is the lack of funding rates that adds a bunch of uncertainty to traders’ P&L known from centralised exchanges.
V1 was under the radar for nearly 1.5 years now, battling extreme market conditions of DeFi summer (& passing the exams!) until V2 shipped in April 2022 and changed the game forever.
Meet Perpetual x5 Leveraged Tokens
V2 contains one of the best fee-generating features in DeFi: Perpetual x5 Leveraged Tokens which took more than 6 months to develop.
Perpetual x5 derivatives are powered by the single $USDC pool that now yields above DeFi-average APY for $USDC LPs:
Let’s hold on for a minute and talk briefly about being a liquidity provider at Uniswap.
You deposit two different assets in a 50/50 ratio to earn swap fees.
It’s all great, but you are being exposed to impermanent loss and your yield from fees depends on more of an occasional type of traders who pay $10–15 for a swap fee (looking at mainnet).
The idea here at CompliFi is that leveraged products enable very high returns, so the associated fees can be legitimately higher than for mundane token trading.
Here’s what happens with LP’s $USDC when deposited into CompliFi:
The protocol uses it as collateral to issue all x5 tokens and allocates them automatically to meet the demand.
Each Perpetual x5 Leveraged Token UP-DOWN pair is collateralised with 2 USDC, and their combined value always stays at that level.
Say a trader buys 500 $MATIC x5 UP tokens. On the opposite side of the trade, the LPs (you) end up with 500 MATIC x5 DOWN tokens. The same reversed scenario happens when a trader buys DOWN tokens.
LPs always take the opposite side of the trade.
Note leveraged tokens are free from liquidations (thanks to 1:1 backing with USDC) and perpetual.
The spot price of a derivative is dictated by the oracle data fed into complifi’s pricing contract (powered by Chainlink oracle feeds).
Perpetual x5s operate in a 24hr cycles. At start, each UP/DOWN token has a value of $1. Once trading begins, x5 tokens derive value from movements in the price of the underlying asset. They do move in opposite directions, within the confines of Up + Down = 2 USDC
A 1% ‘up’ movement of a spot MATIC token is roughly reflected as 5% up for a MATIC x5 UP token.
After that, CompliFi AMM immediately prices MATIC x5 UP at ~$1.05 & MATIC x5 DOWN at ~$0.95.
In this scenario, the underlying $USDC value has been assigned from LPs holding MATIC x5 DOWN to x5 UP.
In extreme market swings, a user can enter into MATIC x5 DOWN token priced at $0.03 and ride it up to $2. That’s a possible gain of 4,900%!
A reminder that x5 markets settle every 24 hours, which means that the values of each UP/DOWN token are back at $1 every 24 hours.
Here’s the spicy part for LPs:
The trader’s x5 position is automatically rolled over onto the next period by using the remaining proceeds to repurchase a new set of UP/DOWN tokens.
Traders willing to maintain their x5 exposure pay fees every 24 hours.
And the person earning fees on that rollover is you, the USDC liquidity provider.
Every 24 hours.
On top of that, LPs earn base fees when traders buy or sell x5 leveraged tokens.
These two factors allow for above market-average APYs for USDC depositors.
Now, the most frequent questions liquidity providers may have:
Where’s the ‘catch’?
Being a $USDC liquidity provider on CompliFi is not risk-free and does not yield linear. When a trader makes a profit and decides to cash out back to $USDC, the payout is covered from the pockets of all LPs in the pool evenly %-wise.
You can also see a high 7-day APY on the $USDC like ~90% pool today because of recent high activity. Still, e.g. a holiday might be around the corner, which will result in lower trading activity -> fewer fees paid to LPs -> lower APY.
LPs should not look here for a get-rich-quit mechanism.
Can I lose money?
The most problematic scenario for USDC LPs is where x5 traders keep consistently guessing the right direction, vintage after vintage. Pools have measures to mitigate that, and traders would need a crystal ball to sustain it.
Note that V2 already managed to withstand the collapse of Luna/UST in early May 2022 that dragged down the whole market. It’s a period when V2 LPs earned a hefty yield:
So…USDC LPs make decent returns only when the market is tanking?
Not really. Imagine being a liquidity provider in a casino. There are days when players make big wins, and the casino needs to issue payouts from their own pockets. But statistically, it’s the house that has the edge over time.
CompliFi’s x5 pool (again, powered by USDC) offers bets in both Up and Down directions, so it doesn’t really care where the market is going. What is important for LPs is that traders have strong views.
Where does that high APY come from?
In short, the high APY on USDC Pool CompliFi comes from two sources: fees traders pay to keep their x5 leveraged positions in the game and a base in/out fee when entering or selling an x5 position.
Note APY on CompliFi can turn negative if traders keep making correct bets and cash out big time.
How sustainable is current (>50%) APY for the USDC Pool?
APY performance is underpinned by trading volume matched to the right amount of capital (i.e. not too much of it is idle). In-demand derivatives are key to good volumes.
Is yield in the USDC pool subsidised with other tokens?
No. LPs in the unified USDC pool earn raw USDC fees.
Can I always withdraw my USDC?
Per CompliFi’s tooltip: At times when all of the pool’s liquidity is in active use, there may be a delay before you are able to redeem your investment. In such cases, withdrawal requests will be queued and processed automatically as soon as liquidity becomes available. Theoretical maximum delay equals the duration of the longest derivative issued by the pool.
This article is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Always do your own research.