Multiple Fee Tiers
Multiple Fee Tiers feature on the Algofi DEX.
In a constant product AMM, liquidity providers (LPs) earn trading fees as a form of compensation for pooling assets. LPs are the market makers of the decentralized trading world, providing assets against which users can trade. Without LPs, there is no market (of course, without traders as well, there is no reason to pool).
LPs take on impermanent loss (IL) risk when providing liquidity. See the Binance Academy Article on Impermanent Loss for more information. When an asset pair (e.g. ALGO / USDC) trends in one direction, up or down, LPs suffer IL. As such, an LP's expected profit and loss looks like:
Expected PnL = Expected Trading Fees - Expected Impermanent Loss
In order for LPing to be a viable strategy, Expected Trading Fees must at least exceed Expected Impermanent Loss.
Now, IL risk is greater in more volatile pools because the likelihood of a trading pair (e.g. ALGO / USDC) trending up or down is greater in pools with greater average volatility. As such, for a given fee level (e.g. 0.30%), higher volatility pools are not viable for LPs because Expected IL exceeds Expected Trading Fees or reduces the PnL to an unacceptable level where other strategies are better to deploy capital into.
The Algofi DEX supports multiple fee tiers because LPs should be compensated more per trade in pools with high volatility. Higher fee tiers for high volatility pairs means that previously unprofitable pools are now viable to trade in. This means the liquidity of these pools will grow and the price impact of future trades will be greatly reduced. Currently, in high volatility, illiquid pools modest sized trades can move the price several percentage points (far greater than the LP fees).
For a given set of two assets, users can create a 0.25% and 0.75% fee tier pool. It is expected the market will converge on a fee tier for each set of assets. It is expected lower volatility asset pairs (e.g. ALGO / USDC, STBL / USDC) will converge on 0.25% while higher volatility asset pairs (e.g. YLDY / ARCA, PLANETS / CHIPS) will converge on 0.75%.
Last modified 1yr ago