Arbitrage & LP Roots
Where did Volatility Farming came from
Roots
Volatility farming is a derivative of arbitrage and liquidity provision. To fully grasp this concept, we must first examine arbitrage and liquidity provision, along with the challenges they present for retail users.
Explaining Arbitrage
Arbitrage, as a concept, simply means buying something at a lower price and selling it at a higher price, profiting from the difference. In the crypto space, this is achieved by capitalizing on price discrepancies of assets across various venues (on-chain, cross-chain, CEX/DEX) and through different strategies (simple, triangular, latency and other).
Consider this hypothetical example:
ETH/USDT is traded on DEX A at a rate of 1 ETH = 3,000 USDT, while on DEX B, the rate is 1 ETH = 3,100 USDT.
A trader buys 1 ETH for 3,000 USDT on DEX A and sells it for 3,100 USDT on DEX B, earning a profit of approximately under 100 USDT after accounting for gas and swap fees.
Sounds simple, doesn’t it? Well, not exactly.
Challenges in DeFi Arbitrage
Currently, DeFi arbitrage is oversaturated with various participants, including market makers, automated arbitrage software, and a limited number of retail users. MEV bots add another layer of complexity, creating intense competition and often resulting in "gas wars" as participants race to exploit opportunities.
Moreover, retail users face significant barriers to benefiting from arbitrage due to:
High Barriers to Entry: Both technological and financial resources are required to compete effectively.
Intense Competition: Advanced automated systems dominate the space, leaving little room for manual strategies and retail participation.
“Dark Forest” Risks: DeFi ecosystems are rife with bad actors exploiting vulnerabilities, making it a risky environment for newcomers.
Liquidity Provision as a Backbone for Arbitrage
For arbitrage to even exist in DeFi, liquidity sources must be available across venues to create price discrepancies. In DeFi, this is primarily facilitated through liquidity pools on DEXs built on Automated Market Maker (AMM) technologies, which rely on user-provided liquidity to operate.
However, utilizing assets with expectation of collecting competitive yield in DeFi is far from simple. Liquidity is fragmented across multiple pairs, chains, and venues, and :
High-Volume Pools: Often experience overutilization, driving APRs down to uncompetitive levels.
Low-Volume Pools: Struggle to generate meaningful APRs due to limited asset utilization.
Drawing an analogy to the California Gold Rush: the ones who profited most were those selling shovels. As crypto evolves and new users enter the space, those attempting to arbitrage their way to profitability often end up incurring losses due to these challenges. In DeFi, the “shovel sellers” are liquidity providers, collecting fees from the use of their assets in trading, including arbitrage transactions.
Nevertheless, to achieve competitive and efficient APRs while managing risks such as impermanent loss, liquidity providers must navigate these challenges above. They must either guess the optimal pools or possess the resources to “sell shovels” across a wide range of liquidity pairs to hedge and collect an averaged yield.
Reimagining Arbitrage: A Safer Ecosystem
What if there were a secure ecosystem where regular users could:
Support a closed arbitrage system by providing liquidity and earning consistent & competitive yield; and
Execute arbitrage opportunities without being overshadowed by MEV bots or bad actors.
This vision of a democratized arbitrage ecosystem addresses the high barriers to entry and the opaque, fragmented nature of DeFi, creating opportunities for all participants.
And we have brought this vision to life through the concept of volatility farming - a approach that transforms market fluctuations into sustainable yield-generation mechanisms within a closed and secure ecosystem.
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