It's now been two weeks since the beginning of the Geyser and the results have been astonishing. The ETH-AMPL pool is now the third biggest pool and AMPL's marketcap has grown from ~$20m to ~$100m.

However, for those who are participating in the program, this leaves a bittersweet taste as they have not been able to see the system's compounding effect on their AMPL and feel like they have missed out a 5x for a 50% pa in the best of cases.

I've been thinking a lot about the implications of participating in the Geyser, so I wanted to explain my take on what the Geyser program actually means to its participants. Please, take everything with a grain of salt as I'm still in the process of learning.

We first need to understand how Uniswap works. To put it simply, Uniswap is a Constant Function Automated Market Maker that allows for people to provide liquidity to a pool with two assets (in this case AMPL and ETH) in the same ratio, and determines the price with the formula: x*y=k. Anyone can then come in and grab some of either one of the tokens in exchange for the other, changing the ratio and therefore changing the price of the token. Depending on the size of the trade / size of the liquidity pool more or less slippage (price movement) will occur.

This means that the larger the pool, the easier it is for anyone to buy or sell into it (as larger trades won't cause as much slippage) and therefore the higher the potential trading volume on it. Each trade is paying a 0.3% fee to the liquidity pool, so higher volume equals higher gains in fees - this is the ultimate goal of providing liquidity.

At the same time, anyone that is providing liquidity to the pool is offering both of their tokens for sale in exchange of the other token in the pool. That causes what is called Impermanent Loss. If the token is going up and I'm the one selling on the way up, at the top I will have many less tokens than if I had not offered them to the pool.

This is even worse due to Ampleforth's rebase mechanism. As the pool is selling AMPL on the way up and it's therefore not getting the rebases of the sold tokens nor the subsequent rebases of those rebases.

However, if we take a deeper look at it we can see that the effect is actually much more interesting.

When a rebase occurs, it creates an arbitrage opportunity between on/off chain exchanges as the price on Uniswap can be taken advantage of directly while on a CEX it has to be traded through the orderbook.

If we looked at an example, assuming no rebase lag, AMPL at $1 and ETH at $200 not changing in price:

The pool would look like:
1 ETH / 200 AMPL (pool is worth $400)

If then AMPL went to $2 and suffered a rebase of 100%:
1 ETH / 400 AMPL (pool is worth  200+400*2 = $1000)

In other words, now 1 AMPL is worth $0.5 in Uniswap while not having changed in price in the CEX. At this point, arbitrageurs have the opportunity to buy them at <$1 on uniswap (depositing ETH) and sell them on the CEX at >$1 which may bring the price on both exchanges back to $1.

Because of Uniswap's constant product function, the USD value of the pool will equalize at sqrt(200*400) = 282.84. In other words, there will end up being 1.412 ETH ($282,84) and 282.84 AMPL ($282,84) in the pool.

The pool is now worth $565.68 and the liquidity providers have gained $165.68, without accounting for any fees.

In summary, providing liquidity resulted in a profit of $165.68 from the original $200 worth of AMPL, while at the peak the total value of those AMPL (including rebase) was $800.

As I said, this leaves us with a bittersweet feeling.

However, I believe that there are a few things to consider:

  • Things won't always be as crazy as they have been the last couple of weeks.
  • Everyone wants to sell at the top, but very few can.
  • This analysis doesn't take trading fees into consideration, but they are very relevant.
  • Rebases near the top have very big impacts on the usd value of the pool.
  • The Geyser's current APY is around 35%, or about 3% per month, which is a very interesting reward by itself.
  • Since the pool is ETH/AMPL, impermanent loss will be cancelled out when ETH goes up vs AMPL. The increase in price - fees + sold rebases - should be permanent (afaik, just as long as no negative rebase).
  • Providing liquidity is very beneficial to the project and therefore to your own tokens. Trying to keep all the compounding rewards from the rebases for yourself can result in a tragedy of the commons.

Finally, while the pool is selling on the way up, it will be buying on the way down. I'm still to fully understand how this dynamic will work. Rebases will lag behind, which means that many more AMPL will be in the pool by the time the rebases happen (increasing the effect of the rebase on the pool), while the price at which the arbitrage will happen will be lower. At the same time, ETH will be freely accessible to anyone that wants to sell their AMPL before the negative rebases kick in, and they will all be able to as the pool will always take the other side. Which force will be stronger? Does the increase in value of the pool have an effect when going down?

In summary, this is a very complex system for which I don't have full clarity yet. I just wanted to share my understanding of the matter as best I could and look forward to hearing everyone's thoughts or if anyone has any data that may be useful to understand the issue.

See you guys tomorrow at the AMPL Geyser Zoom Discussion!