Farmer’s Guide Part 2: Liquidity Pools
Welcome Back!
Whew, not a dull day in DeFi! A lot has happened in just the last two days, some of which we will cover. Thanks for coming back for a more in depth look into farming! If you haven’t read part 1 of the Farmer’s Guide and you are new to this, please check out my article here. If at any point this feels “too newb” for you, just scroll down as the information progresses in complexity.
Tools
- MetaMask wallet
- Etherscan is where you can track anything you’ve done on the Ethereum network. Get comfortable with this on your own.
- Gas Tracker is a helpful site to optimize the timing of your “moves” in Defi. Do most of your work on low gas days if possible.
- Uniswap ROI to track your impermanent losses
- Coingecko for quick access to contract addresses for newer coins.
Level 1: What is Uniswap?
Uniswap is a decentralized exchange that allows you to swap (trade) one ERC20 token for another. An ERC20 token is a token that is functional on the Ethereum blockchain. These tokens are stored or sent using Ethereum addresses and use gas to cover transaction fees. Uniswap’s decentralization is created by the fact that all of the tokens on the exchange are provided by its users.
Let’s say you wanna buy some CREAM and you have some ETH. In order for you to be able to complete that trade, someone has to have provided CREAM to Uniswap. These people are called Liquidity Providers. When you swap one token for another, there is a small 0.3% fee (not including gas) that is charged to you that pays those liquidity providers proportional to their contribution to the pool.
Look at the small print at the bottom of the example and you will see a few things:
Price impact refers to how much change there will be in the price comparative to what it is worth on the market.
Minimum received is obviously the smallest amount you can expect to receive so make sure you are OK with that.
The liquidity provider fee is clearly listed so you can make that calculation yourself if you need to.
Liquidity Pools
As you can seen in the top example, there are two tabs. One says Swap and the other says Pool. The pool tab is where you go if you want to be a liquidity provider.
Let’s say you want to provide some TrustSwap or SWAP to Uniswap. You may have to approve it before you can use it. Once you add and approve a token from your wallet, you shouldn’t have to do it again. The approve transaction should only cost $1–3 in gas. Sometimes your approval is just a signature and it won’t cost you gas.
As you can see there is also ETH there. That is what we call a pair. In order to provide liquidity, you need to pair your token with the equal value of another token. It doesn’t have to be ETH, but ETH is the most common along side some stable coins (see impermanent loss below).
In the example above, I want to provide 300 SWAP with an equal value of ETH .64601 to recieve .01% share of the pool. Once you approve your token or tokens, you will be able to supply them to the market. Click supply, and when the transaction goes through, Uniswap will deposit UNI V2 tokens into your wallet that represent your liquidity pair. People will now be able to purchase the ETH and SWAP you’ve deposited. When someone purchases either of those assets in a trade, e.g., trading SWAP for ETH or ETH for SWAP, you will receive a portion of that 0.3% transaction fee mentioned earlier. At first, you get next to nothing. Over time, you can accumulate a sizable amount for your liquidity.
This isn’t really farming, but depending on the pair you choose and the size of your position in that pair, your percentage of fees can be just as good or better than some farms.
Level 2: Exiting your LP Position and Ratios
Let’s say everything is going well and you want to pull your tokens out of the pool. You want to cash in those UNI V2 tokens for your original tokens plus the fees you have generated. You would simply click on the pool tab and find your pair.
So, I am going to choose ETH/SWAP and it will show me what the current status of my pool is.
Hold on there, Slick. I deposited 300 SWAP and now it only shows 299? Yes. Here is tricky part #1: You aren’t going to get back the same ratio of tokens you put in. You don’t have control over what you get back. However, you do get to see what is coming back to you. If you put in $200 of ETH and $200 of SWAP, Uniswap will still give you back $400 worth of those tokens, provided that those coins still retain their original value. Let’s just say they do (for now). You click remove,
You can decide how much you want to take out. Here, I just put 52% to show it isn’t an all or nothing situation. Your position is shown at the bottom. Click remove, pay some gas, and your UNI V2 tokens are traded for your original tokens in a slightly different ratio.
Impermanent Loss “The Imp”
A lot of people avoid talking about what impermanent loss is because of how complicated it can be to explain. I will do my best.
Impermanent Loss is basically the loss you can expect to incur if your coins in your pair either pump or dump and you remove them from liquidity pools under those either of those conditions.
Dump: If your coins dump, let’s say both go down 30%, and you freak out and want to remove your supply from Uniswap, you will incur that loss. This could also end up with you getting a really weird ratio back. You will still get whatever percentage of fees you’ve generated by being part of the liquidity pool, but once you take out your tokens, you will realize that loss. Those tokens aren’t as valuable now as they were when you supplied them so, the impermanent loss is now permanent. You will get your tokens back -30% + fees generated.
Dump Strategy: I wouldn’t recommend pulling out your LP tokens in this case unless you really need to. In some cases, you may be able to use this to your benefit.
Pump: Let’s say those coins pump 30%. Pumps are good, right? Well, not so much for you (but maybe). When your coins are locked in a liquidity pool, you aren’t going to get the pumped up value. If you were to remove your pair, you will still get a different ratio as we discussed. On the bright side, you will still get your $400 back ($200ETH / $200 SWAP), but if those coins had just been sitting in your wallet and not the liquidity pool, you would have made that 30%. You get $400 in random ratio of SWAP/ETH + fees generated.
Pump Strategy: If your coins pumped, that means that people were trading for them. Depending on how long you had your coins in that pool, you might have generated quite a bit in fees. This depends on the size of your position, time you’ve been in the pool, and what’s happened with those tokens in that time.
Fees: In either case, hopefully, if you have had your coins in for a long period of time, or there has been a lot of trade activity on your pair, you can make up for any impermanent loss with those transaction fees you have generated.
Stable Coins
Should one of the coins in your liquidity pair be a stable coin, you would find it much easier to calculate / mitigate impermanent loss. As you will discover, this is a common practice.
Staying Impermanent: This is a balancing act. If the value of the coins in your pair was to fluctuate wildly but returned to roughly the same value by the time you decided to remove your LP tokens, then you wouldn’t really incur any loss. I’m using “roughly” and “really” here because it is unlikely they would return to the exact same value. Let’s say you put in that $200 SWAP / $200 ETH pair. Two months later, you decide to take it out and it is still about $390. That’s not a super big deal. Hence, the name “impermanent”. Your ratio is still going to be different but you will still have the same amount of money, more or less, + the fees you have generated in that time (which should be pretty good).
Here is a popular chart that may or may not make sense to you.
Tools
Uniswap ROI is a lifesaver here. If you connect Uniswap ROI to your wallet (at your own risk), it will read your UNI LP tokens and calculate the impermanent loss for you. This tool empowers you to time your time your exits efficiently and with confidence. As you will see, there is a lot of information there. Have fun!
Level 3: Big Boy Pants
Now you are familiar with Uniswap and its risks and you want to apply it to farming. Well…
You are now entering the No Crying Zone:
- I don’t wanna hear, “Shillbo, please sir, my family…”
- This is high-risk, high-reward farming
- Be prepared to do your due diligence in research, cold-coffee drinking, and sleepless nights.
- You can never do enough research
- NONE OF THIS IS FINANCIAL ADVICE. These are just steps that I take to do what I do, and I thought it’d be cool to show you.
Ahead of the Curve
Keep in mind that if you can understand and/or do any of this, you are way ahead of the curve. People still haven’t FOMOed into Bitcoin. Bitcoin people still haven’t FOMOed into DeFi. Some of the applications I am about to show you are brand new as you will see. So, be patient with yourself and the market and don’t get in over your head. Start small, gain confidence in the tools, and gradually increase your position with your comprehension.
DeGen Time
Fresh off the market today is SushiSwap. SushiSwap is a fork of Uniswap. You can read more about it in my older article, but a lot has changed since then. If you invested in SushiSwap early, you would have been considered a DeGen or degenerate trader. Why? Well, you can look into that drama on your own. I will say that this project is fully audited now. Today, 9/9/2020, was the official migration launch. It is being deployed by one of the most intelligent people in the DeFi space, Sam Bankman-Fried. This dude doesn’t sleep or cut his hair. He is full time crypto. Please DYOR.
SushiSwap : What’s in it for you?
This is a case of little fish eats big fish. SushiSwap can only work if liquidity pool tokens from Uniswap are migrated successfully over to SushiSwap. What does that mean? That means that because SushiSwap is a fork of Uniswap, the code is inherently the same and can therefore translate your liquidity from Uni to Sushi. Pretty good deal for SushiSwap.
SushiSwap will give you reward tokens (SUSHI) at an insane percentage if you stake your liquidity tokens or LP tokens from Uniswap onto SushiSwap. The APY or Annual Percentage Yields posted here are current from today, post migration. Now, this may change for SushiSwap, but we will continue to use this example as I expect this sort of farming to continue.
Example: If you made a SUSHI/ETH pair on Uniswap and transfer those UNI V2 tokens to SushiSwap, they will begin rewarding you 995.48% of your stake in SUSHI immediately. You will also get extra bonuses for using a SUSHI pair. Also, remember, that 0.3% trade fee from Uniswap? With SushiSwap, if you provide liquidity, you will get a larger percentage of that fee paid to you in SUSHI token. Not only that, but SUSHI is a governance token and holding a lot of it gives you voting power on the direction of the exchange.
Before I give you tips on how to move LP tokens from one exchange to another, understand that there are A LOT of “farms” out there that want your liquidity. Most of them will try to steal from you (not financial advice).
Two relatively safe, yet highly volatile, exchanges where you can do this are SushiSwap and Cream. Cream will reward you mostly when you make CREAM pairs, whereas SushiSwap has a variety of pairs and more tokens. How do you know if a project is legit? Research the team. Research the plans. Research everything you can find. Keep in mind, there is never a no-risk scenario. There will be more of these farms in the future and I will inform you of them if they are seem safe and fun to use.
Finding UNI V2 tokens in MetaMask
If all you use is your MetaMask wallet and UniSwap, you may never need to do this. If you are going to be moving your LP tokens around, then here are some tips to help you so that you don’t freak out when you don’t see them in your wallet.
1. Go to you activity tab in MetaMask and find where you added liquidity. Click on that bar.
2. You will see a window that looks like this. I have edited out sensitive info. Click on the blue arrow to view on etherscan.
3. That will take you to Etherscan information on your transaction. Look down to the middle of the page to where it says Tokens Transferred and find where it shows Uniswap V2 as shown below. Click on that.
4. This will take you to a new page, look on the right and you will find Profile Summary, it will look like this. Mouse over the contract address and you can copy it by clicking copy address.
5. Go back to MetaMask wallet. Click on Assets. Scroll down and click Add Token.
6. Paste the contract address you previously copied into the contract address bar (black rectangle) and click next.
7. You will see this. Click Add Token. Now you will be able to see and manage your LP tokens in your MetaMask wallet. Remember they are ERC20 tokens, so you can transfer them to any Ethereum address.
Measure Twice, Cut Once
You can now move your LP tokens from wallet to wallet. Whatever wallet has them has the access to those tokens. So, if you put them on a crappy farm, they have access to them. Make sure your gamble is worth it. I use the word gamble here, because we are early. Things can break. Use risk management. Do go all in on anything.
This also applies to copying and pasting all those addresses. Make sure you are copying the correct addresses and that you are not accidentally sending money to a contract address instead of your wallet. That HAS happened a lot. Feel free to ask questions. Join Discord groups. Be proactive.
Pro-Tip
If you want to add a new token to Uniswap that they may have, but you don’t see right away, you can always copy the contract address from their contract or find it on Coingecko and add it as a custom token much in the same way I have shown you to do with MetaMask.
From one Newb to Another
This is a ton of information for a newb. And don’t be offended or ashamed to be a newb. I am a newb. We are all newbs. Farming has only been going on for a few months. I simply want to empower you so that, maybe later on, you can empower someone else (or shill me a token you found).
I spent most of my time showing you how the tools can work for you, as that is what is most important. Later, I hope to take some deeper dives into exploring farming options and strategies.
Please be safe out there, and for the love of Bitcoin, make yourself some damn money.
Originally published at https://www.uptrennd.com.
