Architecture Diagram

Hedgability: DeFi Liquidity Pool Strategy Optimization

Introduction

Motivation

In the rapidly evolving DeFi landscape, Uniswap, a leading DEX, plays a critical role. It involves two main actors: LPs and traders. While traders pay fees for swaps, LPs face risks associated with impermanent loss, especially in Uniswap V3. Our solution focuses on helping LPs optimize returns by managing and predicting impermanent loss.

Problem Statement

How can impermanent loss be modeled and estimated from a forward-looking perspective? How can LPs optimize returns and minimize impermanent loss through innovative strategies?

Ideation

Inspired by financial institutions using options to hedge market risks, we explore options in token exchanges to mitigate impermanent loss. Our goal is to empower LPs in DeFi with advanced risk management and strategy optimization tools.

Proposed Solution

Our approach involves modeling volatility to predict impermanent loss and recommending optimal liquidity ranges and options hedging strategies to LPs.

Modeling Impermanent Loss

We use LSTM networks to model and predict volatility. Our methodology draws from Stanford University's research on deep learning for volatility modeling. We derive formulas based on Uniswap's constant product formula and volatility predictions to calculate liquidity pool sizes and impermanent loss.

Hedging Strategy

We propose using options for hedging due to their non-linear payoff structure. We'll recommend optimal options strategies based on predicted volatility, including strike prices and expiration dates.

Conclusion

Hedgability will offer a SAAS platform, providing tailored volatility predictions and hedging strategies for LPs. This includes a custom machine learning model and a comprehensive API.

Key Technologies and Implementation

GraphQL for data retrieval
ExpressJS for backend development
AWS services (SageMaker, S3, Lambda) for cloud infrastructure and model deployment
Jupyter Notebook for data processing and model training
React for frontend development (subject to time constraints)

Backtesting

We evaluated our strategy against three benchmarks using data from the USDC-ETH 0.05% UniswapV3 pool. It's important to note that these results have yet to incorporate returns from the options hedging strategy, which we are still integrating into the tests.