InstaDEX - An AMM on Tezos to Help Mitigate Impermanent Loss
Instadex is a new kind of decentralized exchange that helps to mitigate the usual risks of impermanent loss.
750 words, 4 minute read
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Instaraise - a decentralized Initial DEX Offering (IDO) platform built on Tezos - is gearing up to launch , a new kind of decentralized exchange that helps to mitigate the usual risks of impermanent loss.
DEX/AMM
The name InstaDEX is a play on the term DEX, which refers to a ‘decentralized exchange’. A DEX, or what is sometimes called an AMM (automated market maker), serves an important role in the world of crypto and Web3. AMM DEXs allow market participants to freely trade between different crypto assets without the need for traditional order books or any group of people that stand in between the trades as arbiters. This is because AMM DEXs utilize smart contracts to handle the execution of trades, including all of the math that is used to determine and keep track of the fair market price of an asset.
Liquidity and Impermanent Loss
For AMM DEXs to work, market participants must add liquidity to the smart contracts, otherwise there would be no pool of funds for people to interact with. In other words, without liquidity, there is nothing to trade.The DEX will usually incentivize LPs by allowing their share of a pool to accrue yield that is generated by trade fees.
Traditionally, legacy AMM DEXs require liquidity providers (LPs) to make paired deposits, where each LP puts two tokens - token A/token B - into the corresponding pool. But this kind of paired deposit model incurs what is called ‘impermanent loss’ (IL) - a discrepancy that occurs over time between either the ratio or the value of paired assets, such that the net value results in an unrealized loss (compared to what was initially deposited). Sometimes the yield accrued from trade fees can mitigate IL, but it doesn’t always result in a net positive, depending on market conditions.
This is the problem that InstaDEX sets out to solve. InstaDEX offers two unique features to help mitigate the risk of IL - single asset liquidity provisioning and impermanent loss insurance. The quotes below are taken from Instaraise’s latest blog post, introducing InstaDEX.
Single Asset Liquidity Provisioning
Deviating from the practice established by first generation AMM DEXs, InstaDEX allows users to contribute a single asset to the liquidity pool. By doing so, liquidity providers can overcome involuntary token exposure and continue to earn yields from swap fees charged by the DEX […]
Whenever a single asset contribution is made to the liquidity pool, InstaDEX will compensate the pool with an equivalent deposit of corresponding token […]
The Single Asset Liquidity Provisioning on InstaDEX is applicable for both Network tokens ($INSTA) and Base tokens (tokens other than $INSTA) […] Anyone can contribute base token or network token as liquidity in which case, the protocol will contribute an equivalent value of network token ($INSTA) from reserves. In turn, the LP tokens thus issued will be shared between the protocol and the user, each receiving 50% of the LP tokens.
Impermanent Loss Insurance
The impermanent loss insurance on InstaDEX ensures that every liquidity provider always gets back the same value originally deposited into the liquidity pool at the time of withdrawal […]
A portion of swap fee generated by InstaDEX operations go towards paying rewards to liquidity providers while the remaining goes into the IL protection reserve used to provide IL Protection insurance coverage to liquidity providers.
If the IL protection fund is not enough to cover the losses, the shortfall will be covered by funds from $INSTA reserves to ensure all eligible liquidity provider’s interests are covered.
Single side liquidity provisioning, swap dynamics, impermanent loss, compensation eligibility and amount in an event of impermanent loss are all calculated using mathematical equations.
To learn more about InstaDEX, check out the blog or refer to the InstaDEX lightpaper.