Thread by @Panoptic_xyz

1/13 Why are some pools good 🐶 and other pools bad 😈?

The answer comes from breaking down LP profits into:
1. Price changes 📈
2. Fees collected 🎟️

By comparing LPs to options, we discover parallel insights — let's explore! 🧵

2/13 Price changes
⬆️ Price up: positive return
⬇️ Price down: negative return
⤵️ Payoff determined by delta (Δ) & gamma (Γ) of LP position

Why use options terminology (Δ & Γ) for LPs?
Hint: that payoff looks awfully like a short put option!

3/13 Fees collected
• Determined by theta (Θ) of LP position

🕒 Θ: Rate of time decay (dV/dτ)
💰 dV = fees collected
🧊 dτ = 1 block

→ Θ = fees per block 🤯

✅ Near the money: Θ > 0
❌ Far the money: Θ = 0

4/13 In TradFi, options selling is more profitable when Implied Volatility (IV) > Realized Volatility (RV)

Can we compare IV-RV for LPs?

Yes! But let's use fees instead of IVs since:
• Easier calculation 🧮
• Fees collected ⇔ options premia 👇
• ⬆️ options premia ⇔ ⬆️ IV

5/13 Results match TradFi!

🐶 Good pools (green dots): lie below the line, compensated by high fees given volatility ("IV > RV")
😈 Bad pools (pink dots): lie above the line, not compensated enough ("IV < RV")

(Dot values are summed returns from LPing)

6/13 How do price changes and fees affect returns?

⬆️ Price → ⬆️ LP returns (since fees are always positive)
⬇️ Price → ⬆️ LP returns if Θ dominates
⬇️ Price → ⬇️ LP returns if Δ & Γ dominate

Let's define "dominance" so we can analyze pool returns! 👇

7/13 We define a metric to measure how much fees dominated LP returns

Θ dominance = fees / [ fees + |payoff| ]
(fees & payoff expressed as percentages)

Meaning:
💪100% Θ dominance → fees drove 100% of LP returns
🤕0% Θ dominance → price movement drove 100% of LP returns

8/13 Previously, we found that LPing on $ENS was highly profitable (+124%), but $UNI was not (-28%)

By graphing Θ dominance next to cumulative returns, we find:
😔 Bad days (negative returns) driven by price movement
🥳 Good days (positive returns) driven by fees

9/13 Breakdown of positive & negative returns confirms that
good pool Θ dominance > bad pool Θ dominance:

😔Bad days: 28% ($ENS) > 22% ($UNI)
😊Good days: 59% ($ENS) > 50% ($UNI)

The good pool also had a higher proportion of good days:
🤩ENS: 63% (272/433)
☹️UNI: 55% (335/608)

10/13 The good pool's fees made up for its bad payoffs ($ENS):
Fees: 466%
Payoff: -371%
Return: 95%

The bad pool's fees weren't enough to compensate ($UNI):
Fees: 309%
Payoff: -332%
Return: -23%

(All values are summed)

11/13
📣 Key Insights:

1. LP = short option payoff
2. Δ, Γ, and Θ affect LP returns
3. LPs compensated when IV > RV
4. Good days/pools driven more by fees than by price changes

12/13 Disclaimer:

📢 None of this should be taken as financial advice.
⚠️ Past performance is no guarantee of future results!

13/13 Comment below with questions.

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