MEV Capital Solves Impermanent Loss in DeFi

Decentralized finance-focused asset manager MEV Capital hedges losses related to DEX liquidity provision with short-maturity options contracts.

MEV Capital, a decentralized finance-focused digital asset manager, has launched an options-based strategy to prevent on-chain liquidity providers from suffering impermanent loss – the negative outcome instigated by asset price divergences within liquidity pools.

MEV’s Impermanent Loss-Hedge Liquidity Provider strategy (IL-hedge LP), allows on-chain liquidity providers to capture trading fees without being exposed to the downside risk of their open positions.

The IL-hedge LP, which is live on UniSwap v3, combines a tight-range LP position in a liquidity pool with a package of options – with the same underlying assets and maturity date – to hedge the potential downside while LPs accrue fees from the liquidity position.

“We are excited to add this strategy to our offering. The IL-hedge LP generates competitive returns and offers limited system risk by only dealing with a few smart contract layers of UniSwap and the selected most liquid asset pairs, which we consider top tier,” said MEV Capital Co-founder and Investment Manager Laurent Bourquin. 

Orbit Markets, the options structurer MEV Capital working with on IL-hedge LP, issues a contract that hedges the principal value of the LP position for a specified duration of time, typically one or two weeks. 

At maturity, the options contract is settled over-the-counter with either MEV Capital covering the balance if the LP position has increased in value or the options desk settling the difference with MEV Capital if the LP position is worth less than the hedged amount.

According to research on Uniswap (v3) liquidity pools published by Bancor & Topaze Blue, approximately half (49.5%) of liquidity providers generated negative returns due to the price divergence of two assets constituting the liquidity pool and low frequency of LP rebalancing, also referred to impermanent loss. 

“This particular strategy requires active interaction with OTC derivatives providers for digital assets, as the on-chain liquidity for exotic products is nonexistent for now,” Bourquin said. “However, that’s likely to change. On-chain swap contracts should become available in the following couple of years as traditional financial institutions enter the market en-masse and start reproducing investment products in the DeFi environment in size.”

Besides IL-hedged LP, MEV Capital is bridging the gap between traditional finance and DeFi by offering sophisticated digital asset instruments to institutional investors via segregated managed accounts, covered stablecoin notes, and IL-hedged LP offerings.