Being LP with Iotabee: Part I — APR explained

By Iotabee Last updated Oct 21, 2023

Being LP with Iotabee: Part I — APR explained

Disclaimer: this article is part of our Iotabee DeFi Honeypot column. It aims at providing entry-level knowledge on Decentralized Finance (DeFi) topics for information only. It is not intended, and should not be understood or constructed as financial advice. All investment activities should be carried out with caution and at your own risk.

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If you’re reading this article, you are probably interested in being a liquidity provider in DEX, or you already tried adding liquidity on Iotabee, and would like to further understand the gains and loss, or obtain some tips on the general operations. If that’s the case, you’re in the right place!

This subject will be divided into two parts. Today we’ll cover Part I — APR, and in Part II, we’ll provide more explanation on the Impermanent Loss. We have actually briefly covered the Impermanent loss before, you may already check this article here.

Ready? Let’s go!

What is APR?

APR refers to Annual Percentage Rate. When you provide liquidity on Iotabee, it reflects the estimated annual yield rate generated by the deposited assets. Currently, the APR shown on the Iotabee pool page is a collective APR for the whole pool. We’ll hopefully add other APR indicators soon for a better visibility.

On Iotabee, the APR is an estimated annualized value based on the transaction history and it is also a compound interest (meaning your earnings are also automatically added to your original liquidity to earn yield, so the APR formula on Iotabee is:

APR = [(5/6) * fee / (TVL*days) + 1] ^ 365–1

There is the “ (5/6)*” in the formula because the liquidity providers on Iotabee eventually earn 5/6 of the total trading fees, while the remaining 1/6 go to Iotabee team and its partners.

If a pool exists for fewer than 7 days, we’ll take the total fee of the past days for the calculation;

If a pool exists for more than 7 days, we’ll take the total fee of the last 7 days.

How is the APR impacted?

The compound interest is higher than simple interest, but here for the ease of calculation, we’ll use a simple interest formula here to demonstrate how the APR is impacted.

Conclusion first: the APR is mainly impacted by the ration of daily trading volume vs the TVL, and the fee rate.

Let’s start with the simple interest formula:

APR = (feeA + feeB) * 365 / 7 / (reserveA + reserveB)

where:

feeA means the total amount of trading fee generated by Token A;
feeB means the total amount of trading fee generated by Token B;
reserveA means the total amount of TokenA in the pool;
reserveB means the total amount of TokenB in the pool

Let’s also set that,

the daily trading volume of a pool Token A/ Token B is v;
the fee rate (as percentage) is r;
the daily fee is f, while f = feeA + feeB = v*r;
liquidity providers daily fee is f(LP) = 5/6*v*r
the TVL ( Total value locked = reserveA + reserve B) of the pool is T.

The APR is an annualized Daily Percentage Rate (DPR), based on data in the past 7 days, while:

DPR = f(LP)/T = (5/6*v*r)/ T = 5/6*(v/T)*r

Hence,

the bigger the v/T and the r is, the higher the DPR will be.

Some concrete calculations:

On Iotabee, the r is fixed for different trading pairs:

for stable pairs like USDT/MIOTA, r = 0.3%

for volatile pairs like SMR/MIOTA, r= 1%

So now the key would be the v/T. It will be hard to estimate, but we can look at other crypto market for reference:

Data of uniswap (largest DEX)：
https://info.uniswap.org/#/
v/T = 19.8%（2022.9.30）
Data of pancake (largest DEX on BSC) : https://pancakeswap.finance/info/#/
v/T = 6%（2022.9.30）
Data of quickswap (largest DEX on MATIC)
https://quickswap.exchange/#/
v/T = 5.5%（2022.9.30）

v/T is highly relevant to the market itself.

In a bull market, the v/T can go rocket high. We assume that on a long term, the v/T may be between 5% — 10% in our ecosystem.

If we do some concrete calculations based on this assumption:

When the v/T is 5%:

APR for stable trading pairs like USDT/MIOTA (r=0.3%) is appoximately 4.6%:
APR = 365 * DPR = 365*5/6* (v/T)* r = 365* 5/6 * 5% * 0.3% = 4.6%
the APR for volatile trading pairs like SMR/MIOTA (r=1%) is appoximately 15.2% :
APR = 365 * DPR = 365*5/6* (v/T)* r = 365* 5/6 * 5% * 1% = 15.2%

When the v/T is 10%:

APR for stable trading pairs like USDT/MIOTA ( r=0.3%) is approximately 9.125%:
APR = 365 * DPR = 365*5/6* (v/T)* r = 365* 5/6 * 10% * 0.3% = 9.125%
APR for volatile trading pairs like SMR/MIOTA ( r=1%) is appoximately 30.4% :
APR = 365 * DPR = 365*5/6* (v/T)* r = 365* 5/6 * 10% * 1% = 30.4%

A few practical tips:

When providing liquidity, especially for volatile trading pairs, make sure that you pay close attention to price changes. There is no bonding time on Iotabee for your liquidity. You can withdraw or add at any time;
If you’re not sure about the price trend, one good strategy is to start small; the other good one is to divide the total amount that you’d like to invest in several smaller portions, and only add one portion at a time, or none at all when you feel that the risks are high. This may help you control the overall risk, and gain more experience with time;
All-in is never a good strategy unless you’re absolutely clear on what you’re doing, and what you may gain or lose.

Alright that’s it for today. We hope this article can be helpful!

Let us know what else you’d like to see here, and we’ll see you again soon in Iotabee DeFi Honeypot! Happy Trading! ????