To put into perspective how insane this is, 1000 USD compounded annually at 680% for 10 years is 833,577,583,123.6199424 USD.
Yes, 800 billion USD.
Now, of course, there’s a lot of nuance that my simple compounding has ignored.
You’re definitely not going to make 800 billion off 1,000 dollars in 10 years or even a hundred, but there’s an unprecedented opportunity for anyone using Meteora’s new pools.
I know you’re anxious to jump in, but if you’re going to understand and capitalize on DLMMs, you need to understand LPing, Impermanent Loss and existing AMM structures.
If you don’t know what any of that means, I got you.
If you’re an experienced LPoor and you just want to get to the part where you make 800 billion, you can skip to here.
If you’re intermediate, or you’d like a refresher, feel free to start from any section you feel comfortable with.
If you’re an absolute beginner, read through the entire thing. I’ll tell you everything you need to know to start using the new Liquidity Pools.
I’ll also add some strats to farm multiple airdrops while you’re at it.
LP is short for Liquidity Provi(der/son), it can also mean Liquidity Pool but context will help you know which one is being referred to per time.
OK, what does an LP do?
The entire point of blockchains is to get rid of centralized entities and middlemen.
The problem is P2P finance is highly inefficient because of the complications of matching buyers and sellers. Called the central-limit-order-book (CLOB) method.
So some geniuses had a bright idea.
Instead of trying to match buyers and sellers, people deposit their money into a pool, and anyone at any time can perform transactions through the pools.
The LPs are incentivized by the fees they earn on transactions, and the pools always quote market prices.
And because the entire system is managed by permissionless smart contracts, it aligns perfectly with blockchain ethos.
And so the Automated Market Maker (AMM) model was born.
AMMs
In the AMM model, each Liquidity Pool usually holds two tokens. One base token and one quote token.
When you deposit liquidity into the pool, you usually get a special type of token called an LP token. The amount of LP tokens issued is proportional to the size of your deposit relative to the overall pool size.
The entire pool earns fees from swaps executed through it.
You can redeem your share of liquidity (and fees) at any time based on the number of your LP tokens relative to the total number of LP tokens.
The price of the tokens in your pool is managed by the smart contract and arbitrageurs, but we’ll get to that later.
I’m sure you can already imagine how much better this system is than trying to match buy and sell orders. However, AMMs come with their own unique kinks, the biggest of which is impermanent loss (IL).
Impermanent Loss; the bane of LPing
Impermanent Loss (IL) is the “loss” an LP incurs when the price of their tokens diverge from the price when they were originally put in the pool.
If I were to fully explain impermanent loss, this article would be significantly longer, so I created a separate article for those interested in the math. I’ll link it at the end.
The key concept is:
Say you put SOL and USDC in a pool.
If the price of SOL goes up, more people must be buying SOL. So it follows that you’ll have less SOL and more USDC in the pool.
You might expect that you’ll always have equivalent value since USDC is being added, but that’s not the case.
You’ll incur some loss compared to holding depending on how far the prices diverge.
Here are a few scenarios and the impermanent loss you’ll incur:
a 0.5x divergence results in 5.7% loss relative to HODL
a 0.6x divergence results in 3.2% loss relative to HODL
a 1.25x divergence results in a 0.6% loss relative to HODL
a 1.50x divergence results in a 2.0% loss relative to HODL
a 1.75x divergence results in a 3.8% loss relative to HODL
a 2x divergence results in a 5.7% loss relative to HODL
a 3x divergence results in a 13.4% loss relative to HODL
a 4x divergence results in a 20.0% loss relative to HODL
a 5x divergence results in a 25.5% loss relative to HODL
As you can see, the losses aren’t huge per se.
If SOL doubles in value, you’ll only lose 6% and you’ll earn fees from LPing.
But you still need to keep this in mind, especially with high volatility pairs.
LPing is all about striking the balance between fees and IL.
I encourage you to read the full derivation linked at the end if you’re serious about LPing.
But now that you have an understanding of all the basics, let’s move on to LP structures, how they work, and why Metora’s DLMM is better.
Predecessor LPs: AMMs and CLMMs
Meteora’s DLMMs have two predecessors: AMMs and CLMMs (we skipped BLMMs).
AMMs
AMMs are the basic form of LPs. They work exactly as described earlier.
You provide liquidity and earn fees.
They are governed by the constant product algorithm:
I won’t get into how this works under the hood; you’ll find that in the impermanent loss breakdown.
What you need to know is that because of the above equation, you’ll always have some token X and some token Y.
This sounds great because your pool is always open for business, but the side effect is that the amount of liquidity in your pool that is actually available for trading at each price point is infinitely small.
In AMMs, you need very deep liquidity for your pool to be able to execute swaps without insane slippage. And most of this liquidity just sits there until prices are in range.
It’s this inefficiency that led to the birth of CLMMs.
CLMMs: Concentrated Liquidity Market Makers
CLMMs are similar to AMMs with two “small” changes:
If the name didn’t give you a hint, in CLMMs, all your liquidity is concentrated into a particular range instead of spread from 0 to infinity.
Because CLMMs are distributed over a definite range, your liquidity is used far more effectively, and you earn more fees with less capital.
The difference is the equivalent of going from horse-drawn carriages to a Ferrari.
CLMMs are discrete
By discrete, I mean your liquidity is deposited into specific positions called ticks.
For example, if you deposit into a SOL/USDC pool from 99 USDC per SOL to 101 USDC per SOL, your liquidity could be distributed like:
20% at 99 USDC per SOL,
20% at 99.5 USDC per SOL
20% at 100 USDC per SOL
20% at 100.5 USDC per SOL
20% at 101 USDC per SOL
So instead of continuously changing prices, trades through CLMMs exhaust liquidity in a tick before moving to the next price point. That means zero slippage for transactions that occur within a tick.
In summary, CLMMs are much better than AMMs.
The only issues with CLMMs are:
that you run a greater risk of impermanent loss.
The risk of impermanent loss is inversely proportional to the width of your position, and it can be much higher than an AMM pool.
You need to rebalance/monitor your position more often.
Because you only provide liquidity for a certain range, once price starts trading outside your range, you stop earning fees until you rebalance or open a new position.
So what exactly is Meteora’s DLMM?
DLMM is short for Dynamic Liquidity Market Maker.
A DLMM is pretty similar to a CLMM in that you deposit liquidity into discrete ticks (this time called bins), but there are two key differences: customizability and dynamic fees.
Customizability
The standard for AMMs and CLMMs is that your liquidity is spread evenly over the predefined range (0-infinity) in AMMs and (across X ticks) in CLMMs.
In DLMMs, the liquidity is spread, however you like.
Take the scenario I painted for CLMMs, in a DLMM, you could have:
9.2% at 99 USDC per SOL,
5.5% at 99.5 USDC per SOL
70.3% at 100 USDC per SOL
12% at 100.5 USDC per SOL
3% at 101 USDC per SOL
DLMMs place no restrictions on how to distribute your liquidity.
This allows you to capture more fees if you have a good inkling of how the market will behave.
Here are the three basic liquidity distributions:
Spot
Spot DLMMs are essentially CLMMS.
You break up your liquidity into equal distributions over a number of bins. The number of bins can be few or many; your choice.
Curve
A curve is a well, a curve.
The curve distribution allows you to concentrate most of your liquidity in a small range but also allows you to earn fees should price move out of your range.
Bid-Ask
The Bid-Ask is an inverted curve, and it’s pretty weird. Almost seems like it’s begging for impermanent loss, but it actually has some practical uses that we’ll highlight later.
So aside the basic spot option you’re already familiar with, DLMMs open the door to new liquidity distributions. And so far, we’ve only discussed the three basic options that are currently available to users. You can combine different distributions to make your own unique distributions. And developers can take full advantage of Meteora’s SDK to spin up shapes of their own.
Dynamic Fees
The second major difference between DLMMs and other AMMs isa dynamic fee feature. Dynamic fees are extra fees that pop up during high volatility trading periods, more on them later.
How does a DLMM pool work exactly?
Like I said earlier, in a DLMM, you deposit liquidity into strictly defined discrete bins.
Only one bin is executing trades per time, and all bins except this active bin contain a single token.
Let’s say it’s a SOL/USDC pool.
If SOL is trading at 100 USDC/SOL, the 100 USDC/SOL bin is the active bin, and that means all bins to the left of it will be full of USDC, and all bins to the right (representing higher SOL/USDC prices) are full of SOL waiting to be traded for USDC.
The difference between consecutive bins is called the bin step. It determines how close or spread out your ticks are. Larger bin step; more spread out, smaller bin step; more compact.
Bin step measured in basis points (fancy financial term for percentage of percentage, i.e 1 basis point = 1/100 % = 1/10000 = 0.0001).
The bin step and number of bins are set when creating the pool. But you can open infinitely many positions within the pool.
The result of this system is unprecedented capital efficiency.
Let’s take a look at the advantages of DLMMs for LPs and project teams.
Why LPoors should use DLMMs
Ultra-efficient capital efficiency.
DLMM’s discrete bins and distribution flexibility are the pinnacle of capital efficiency. Your tokens will be used exactly where you deploy them and nowhere else. There is literally no greater level of capital efficiency. Literally!
Dynamic Fees
DLMMs open the door to a new type of fee called “dynamic fees.”
Dynamic fees consist of additional fees paid on top of the normal base fee. These fees are triggered when a swap spans multiple bins.
The exact relation is complex, but the idea is, volatility can be measured based on the rate of change of bins. If bins are being changed often, it indicates that there is a large number of trades occurring.
Meteora capitalizes on this demand and adds additional fees on top of the base fees during these periods. This is great because volatility is usually correlated with impermanent loss and the additional fees can help make up for it.
Zero-Slippage Transactions
This is a benefit for users that creates a value flywheel.
Because a bin is a single price point, any order that can be filled within a bin experiences absolutely no slippage. Users are more likely to use DLMM pools as a result, and as such, they generate higher fees, which motivates LPs to add more funds to their positions. the bins get deeper, and it goes on and on and on.
Why Project Teams should use DLMMs
New Ways to Launch Tokens: DLMMs open up new ways for project teams to launch their tokens. JUP used a DLMM pool; need I say anything else?
Flexible Token Design: Project teams can design their own bonding curves with DLMMs.
For example, a project team could use a bonding curve to effectively control token prices by varying how much liquidity is available at what prices.
In essence, you can now design your own support and resistance zones and even build buy and sell walls.
The benefits of DLMMs for users, LPs, and project teams are pretty insane.
The only thing LPoors have to be careful about is that with great flexibility comes great impermanent loss. The flexibility also means that you have to be more careful with the distribution and price ranges you select.
With that in mind, here are a few of my favorite strategies to maximize DLMMs.
How to use DLMMs (Strategies)
Normal LPing with an edge.
You can use the DLMMs like you would any other CLMM.
The major difference is you have an edge (or two)—customizability and dynamic fees.
Stablecoin and LST fee maximization.
Another strat I really like is using the curve distribution with stablecoin or LST pairs (LST/SOL).
These tokens usually trade in a very tight range, so most of your liquidity should be concentrated within that range as well. Using the curve distribution allows you to do this while also earning from small deviations.
Buy/Sell Walls
This is one of my favorite use cases for DLMMs.
If you have deep enough pockets, you can use DLMMs to create a sell/buy wall.
You just have to deposit very deep liquidity (relative to volume) into a particular bin, and your token will never fall below or go above that price.
DCA-ing in/out while earning fees
This is a creative use of DLMMs, and it’s easily my favorite.
Meteora has a single sided supply option that allows you to supply a single token in any distribution you like - Spot, Curve, Bid-Ask or a mix of all three.
You can use this to DCA-in or out of a position and earn trading fees doing it.
It’s an easy way to automate entering or exiting a position and make free money while doing it.
Using Bid-Ask to LP high volatility pairs
If you think a pair will trade between two price points with significant volume towards the edges, Bid-Ask is a great way to maximize fee earnings on that pair. It’s great because it takes what used to be the biggest problem of LPing (volatility) and makes the best of it.
A few advanced strats are:
Ladder Orders
Ranged Limit Orders
De-Peg Bets
There are numerous potential applications for DLMMs; all you need is a little creativity.
As we approach the end of this, here’s some free airdrop alpha too.
Airdrop strats with DLMMs
There are four airdrops you can farm using DLMMs: MET points, Kamino points, BLZE tokens, and JUP.
Here are a few strats to farm all of them:
Using DLMMs
Just using DLMMs earns you 2x MET points.
Kamino’s Vaults
Kamino integrated Meteora’s DLMMs into their vaults, and Meteora has confirmed that using particular vaults allows you to earn MET points in addition to Kamino points.
The vaults are: WEN/JUP, WEN/SOL and JUP/USDH.
Triple Stacking
Triple Stacking is a strat that allows you to farm token rewards in addition to Kamino and MET points. This is a time-sensitive strat as most of these campaigns end February 28.
You can find more information on Triple Stacking and Kamino’s Vaults here.
bSOL pools
Using bSOL in Meteora’s DLMMs allows you to earn MET points and $BLZE tokens.
JUP Farming
Using DLMMs with any JUP pair is a great way to farm JUP and MET in preparation for the next JUPary. You can increase your exposure by depositing your JUP-LP tokens into the JLP/SOL pool for even more rewards.
Overall, none of this should be taken as financial advice.
All I’m saying is it’s a great way to earn.
FAQs
What happens when price trades out of range? Does it automatically rebalance?
When prices trade out of your range, you’ll be left with only one token. For example, if you open a SOL/USDC pool and SOL prices drop out of the range you originally created, you’ll be left with all SOL and stop earning trading fees.
You have two options at this point:
Leave the position and wait for price to come back in range or
Close the position and reopen a new one. If you do close the position, you’ll realize the impermanent loss incurred, so be careful.
In conclusion, the innovation behind Meteora’s DLMMs is on the same level as going from a Ferrari to a supersonic jet, and for a short time, you can farm airdrops too.
For beginning and intermediate LPs, you should start practicing immediately.
This was an insightful read. Thanks!