Welcome to our second learning session; previously, we have learned about Stable Pools. Today we are covering Weighted Pools, how they work and how advantageous they could be for Wavelength’s users.
What are weighted pools?
Weighted Pools are highly versatile and configurable pools that use a modification of the standard CPMM algorithm popularised by the early DEXs like (Uniswap).
Weighted Pools use Weighted Math, which makes them great for general cases, including tokens that don’t necessarily have any price correlation (ex. DAI/WETH). Unlike pools in other DeFi protocols that only provide 50/50 weightings, WavelengthWaveLength Pools enable users to build pools with different token counts and weightings, such as pools with 80/20 or 60/20/20 weightings.
How do weighted Pools Work?
Wavelength’s Weighted Pools can contain up to 8 different tokens. Upon creation of a Weighted Pool, every asset is assigned a weight, which defines what percentage of the pool is made up by each asset.
Wavelength Weighted Pools generalize the x * y = k equation by accounting for uneven weights and asset counts greater than 2.
Above is the equation that enables these pools, where V is a constant, B is an asset’s balance, and W is an asset’s weight in the pool.
As the price of each token fluctuates due to trading activity, so do token weights. However, arbitrageurs will find arbitrage opportunities and rebalance the pool by making swaps that bring each asset back to its assigned weight.
Unwanted exposure to a given asset is a common problem with traditional pools. A Liquidity Provider (LP) may, for example, not want to be exposed to $USDC but find no other pair for the $VLX coin.
With Weighted Pools, users have better control over the levels of exposure to particular assets while maintaining the ability to provide liquidity. In these pools, a higher token weight means less potential for impermanent loss in a price surge or market downturn.
For instance, if a user wants to provide liquidity to both $WBTC and $WETH, they can choose the pool with the weightings that align most with their strategy. A pool composed mostly of $WBTC implies they favor exposure to $WBTC over $WETH. In other words, it indicates the Liquidity Provider expects better price performance from $WBTC. Using the same logic, an evenly balanced pool (50/50) points to expectations of similar-sized gains on both assets.
For the reasons mentioned above, passive investors, who although they desire only exposure to certain markets may have a semi-formulated thesis, will find Weighted Pools optimal for their strategy.
The image above represents exactly what was explained in the previous paragraphs. In this example, a Liquidity Provider has 3 choices for the $VLX/$WAVE pair. Either favor exposure to one of the assets or opt for an even pool composition.
Impermanent Loss (IL) is a temporary loss in deposit value that LPs experience when they join a pool. It is often depicted as the difference between the results of holding an asset outright and providing liquidity in it during a given period of time. Impermanent loss is usually observed in traditional liquidity pools where the LP has to deliver a volatile token pair at a set ratio.
With Weighted Pools, there is far less impermanent loss. However, this doesn’t come for free. Highly asymmetric pools offer increased slippage to traders due to the fact that one side has much less liquidity.
80/20 pools have emerged as a happy medium when balancing liquidity and Impermanent Loss mitigation.
As suggested by the image above, different tokens weights result in different IL potentials for LPs. The chart is in total accordance with the claims made about Weighted Pools. Indeed, the chart indicates that the 80/20 and the 95/5 pools suffer significantly less from IL than the 50/50 pool.
In this post, we explored the benefits of Weighted Pools and both their strengths and weaknesses. Once again, due to the protocol commitment to delivering the most advanced DEX on Velas, Wavelength users will have access to a range of Weighted Pools and will also be able to create their own custom ones.
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