Cover Pools
Last updated
Last updated
Cover Pools allow you to create positions to increase exposure to a specific token conditional on it increasing in price on a given pair.
If the price of ETH goes up, the pool sells DAI and increases its exposure to ETH.
If the price of ETH drops, the pool sells ETH and increases its exposure to DAI.
If a position is or has been in range on a bidirectional automated market maker it increases the exposure to the token dropping in price or has all exposure to the token dropping in price.
If there's a demand for ETH in the market, the pool utilizes DAI to raise the ETH-to-DAI price.
If there's a demand for DAI in the market, the pool uses ETH and lowers the ETH-to-DAI price.
This allows them to function as a hedging tool if the user wants to enter or exit an ERC-20 token over some range.
If you try to do this using a fixed price position like a limit order (which is typical when providing liquidity), the position may end up undervaluing the assets or not getting filled at all.
Cover pools enable you to set a price for providing liquidity, and when the TWAP price gets close, the liquidity becomes accessible for trading. It's then included in a Dutch auction.
Cover Pools work through a Gradual Dutch Auction (GDA), allowing you to begin with the price indicated by the current position's price tick and gradually offer more discounted prices until the market accepts.
As a Range Order, Cover Positions will release liquidity at different times within a specific price range. This happens as the Time-Weighted Average Price (TWAP) either goes up or down, as chosen by the user.
This is because we aim to prevent the pool from releasing liquidity in response to frequent market fluctuations, especially situations that could be quickly exploited through arbitrage and closed out in a very short time.
If you want to protect against impermanent loss as the price changes, it's a good idea for the lower and upper bounds to align with your current position on Uniswap v3 or BitPool. You can set the same upper and lower bounds as in your original Range Position NFT. The BitPoolCoverPair contract will automatically figure out how much input token you need to transfer into the pool based on the current valid price range.
For users looking to make their capital usage more efficient, they can either increase the lower bound or decrease the upper bound. This way, less upfront capital is needed.
On the other hand, Cover positions are designed to reduce exposure to one asset and increase exposure to another as the price of the initial asset worsens. This provides LPs with a way to protect a part of their portfolio in case the market price moves against a particular asset.
If the user aims to protect against potential impermanent loss, it's important for this range to align with their initial LP position. Additionally, the value of the position should be equal to better address impermanent loss.
For users who want to trade into an asset starting at a specific price (as shown in the image below), they can establish the lower bound as the point where they intend to begin shifting from the input token to the output token.
The Cover Pool will release liquidity at each price point, determined by the total available liquidity in the pool for a particular pair direction.
To enhance capital efficiency, users can choose a smaller range for trading to the desired output token.
Cover LP Positions can also serve to reduce the exposure of long or short positions before facing liquidation.
To stay competitive with the prevailing market rate, the pool needs a flexible pricing mechanism to fill the position quickly while minimizing any discount. Cover Pools achieve this through Gradual Dutch Auctions, adjusting the pool price (based on whether buying or selling a token) to meet the market demand for an asset within a trading pair at that specific moment.
From Paradigm's Gradual Dutch Auction article:
By bringing together these values, we get a market price that changes exponentially for each unit of liquidity we auction. The price will not vary by more than one price tick, for instance, 0.1% for the ETH-USDC 0.05% tier.
When creating a pool, volatility tiers establish several parameters: auction length, syncing fee, minimum position size, and minimum position width. The auction length represents the number of blocks until the next auction can be triggered by a price change. A syncing fee comes into play when an auction goes unfilled, and it needs to be moved to the next price tick, with liquidity added at the new price tick. Minimum position size is the smallest amount of liquidity needed at a price tick to start an auction. Minimum position width denotes the minimum number of price ticks a position can cover.
