5 Ways Clipper’s Yields Attract & Retain Liquidity
Clipper is the DEX for blue-chip swaps. Today, blue-chip tokens (namely ETH, WBTC, and popular USD stablecoins) comprise 70% of all DEX trading volume. Clipper already provides best prices for retail traders and with more liquidity can now also provide best prices on larger trades. At $50M of liquidity, Clipper should mathematically have the best prices on trades up to $50k, which would maximize protocol fees. A liquidity level above $50M would increase volume, but not necessarily protocol fees. This is because there aren’t enough trades in the market to offset the dilution to yields from extra TVL. This post describes the three ways yields might attract more TVL, why LPs will stay, and how market trends may affect this.
Attracting TVL
Liquidity mining can quickly acquire TVL
DeFi has a well-established history of attracting TVL using liquidity mining incentives. Typically, this mercenary capital doesn’t stay because most pools that rely on liquidity mining lose money for LPs. Clipper is different in that it actually makes money for LPs, which means that once TVL is acquired it’s within LPs’ best interests to leave their liquidity in the pool. In other words, liquidity mining can be used solely for customer acquisition. See below for more info on retaining liquidity.
ClipperLP is sound collateral for high-yield looping strategies
For those who want higher yields, they can achieve them using leverage. Because ClipperLP tokens are instantly and permissionlessly redeemable for the same blue-chip assets used as collateral in many lending protocols, we expect lending protocols to soon offer loans with ClipperLP as a collateral option. This will enable leveraged looping strategies, like those on DeFiLlama’s leaderboard for leveraged lending strategies. Note: Please see footnote [1] on using leverage responsibly.
Yield growth accelerates with more TVL (until $50M)
All DEXs face tradeoffs with liquidity. On one hand, it improves prices on larger trades, which attracts more volume and generates more fees. On the other hand, more TVL dilutes APYs because those fees are spread across more LPs. To figure out the amount of TVL that would generate the highest yield, we analyzed a sample of 10,000 1inch trades at least partially filled by Clipper (e.g., Clipper might fill the first $10k while other DEXs with more TVL filled the remaining $40k, like these). Based on this analysis, Clipper will maximize yields at $50M. Until the $50M mark, more TVL should generate higher yields in a positive feedback cycle.
Retaining TVL
Clipper retains liquidity because its organic yields are above-market
Clipper’s liquidity pool is designed to meet or beat the benchmark of a daily rebalancing portfolio. Rebalancing portfolios are known as the ‘only free lunch in investing’ and harvest relative mean-reverting volatility to generate yield by systematically buying low and selling high. You can see Clipper’s performance against this benchmark here. For HODLers, since Clipper’s last deployment at the start of Q2 2023, LPs outperformed HODLing each month by 0.6%, 3%, 21% and 34%.
Note that these are actual profits for LPs. However, in DeFi, most people like thinking about fees while ignoring impermanent loss (IL). To help provide some useful comparisons, Clipper adds back ‘avoided impermanent loss’ to arrive at a “Comparable APY,” which it reports in real-time here. As of this writing, Comparable APY is about 8%. In market conditions with lots of IL, this has frequently hit 50%+ This is perhaps the highest yield in DeFi for these blue-chip assets (e.g., the blended Compound.finance earn rate on these assets is only 2.41%). Moreover, it is almost certainly the best risk-adjusted yield (best Sharpe Ratio).
This is the difference between Clipper and other DEXs–because it’s underlying yields are positive, liquidity is likely to remain once attracted.
Market Trends
Trends in market structure should drive Clipper yields higher relative to other DEXs
Major DEXs and aggregators are moving towards a gasless RFQ model where off-chain market makers get the first look at orders before routing to AMMs. UniswapX is the latest example of this and 1inch Fusion, Cowswap and others have a similar approach. This will have a dramatic effect on the AMM landscape. Here’s how:
Initially, market makers will fill the profitable tradeflow (e.g., price moved favorably in the several second blocktime since the order was placed) and leave only the toxic tradeflow for AMMs. This is likely to decrease LP returns in traditional CFMMs. But RFQs from private market makers aren’t composable and can’t be chained into multi-hop trades (e.g., USDC -> ETH -> BAT) because they are size-specific such that outputs don’t scale with varying inputs from prior hops. That means they can’t serve this market.
Clipper’s unique FMM architecture brings prices on-chain as fast as any off-chain market maker (in comparison to other DEXs). This macro trend in market structure should be a strong tailwind in increasing yields. It can avoid the toxic flow that other DEXs are exposed to while still serving the composable market, resulting in higher and higher yields relative to other DEXs.
Conclusion
There are many paths for Clipper to attract more TVL. Most will simply happen on their own, others will happen as market trends play out, and liquidity mining will be up to the community. Decentralized governance is in the driver’s seat. Hopefully. this post provides the context they need to make the best decisions for the protocol.
Footnotes:
[1] For context, leverage can be a powerful tool when used responsibly. Namely, basic financial theory teaches that the optimal portfolio management strategy is not to invest in the highest-yielding assets, but rather to invest in the assets with the best risk-return ratio, and then use leverage to amplify the return (along with the risk) to meet the desired yield. This is actually more rational than investing in an asset with higher unlevered return but even higher unlevered risk. Put another way, you first find a portfolio on the efficient frontier and then lever it up to your desired return.