In decentralized finance (DeFi), decentralized exchanges (DEXes) require liquidity providers (LPs) to facilitate liquid markets. These liquidity providers deposit their assets into pools, enabling traders to easily swap tokens, ensuring smooth and efficient trading without the need for centralized intermediaries.
With Marginal, our pools are further enhanced to enable a decentralized leverage trading experience for any token onchain. How does this work, and how are LPs able to get a better earning opportunity on Marginal?
Marginal Liquidity Provisioning
Marginal's liquidity providers pool two tokens, X and Y, into designated liquidity pools. These pools utilize an Automated Market-Maker (AMM) formula, enabling passive market-making.
These pools serve as the foundation for the perpetual market, where traders take leveraged positions by borrowing from the reserves. When traders borrow from the pool to increase their exposure to either X or Y token, they execute a series of trades, exchanging one of the borrowed tokens for additional exposure on the other token.
Throughout this process, the liquidity remains overcollateralized as leverage traders need to provide collateral of their own, providing security for LPs and the platform itself.
At the end of a trade, the trader returns the borrowed tokens back to the pool to retrieve their collateral, plus any profits or losses from the trade. This system ensures that the liquidity pool remains whole and LPs retain their assets while earning fees.
Earning Opportunities for Liquidity Providers
With this system, Marginal LPs not only earn from swap fees, but from the following:
Leverage Trading Fees
Every time traders utilize liquidity to take a trade, they pay fees. These fees are distributed to LPs, proportional to their contribution to the pool.
Funding Rates
Marginal applies funding rates to leveraged positions. This funding mechanism charges traders based on the difference between the platform's time-weighted average price (TWAP) and the oracle price sourced from the Uniswap v3 oracle. LPs benefit from the fees accrued through this funding process.
Liquidation Fees
When a trader’s position gets liquidated, the trader’s posted collateral goes entirely to the pool. Depending on the trader’s leverage level, 10-25% of the initial borrowed amount gets returned to the pool as a liquidation fee, which can be quite the bonus!
How Marginal Protects Liquidity Providers
One concern of potential LPs is the potential of more risks by this new system. But the Marginal platform incorporates several safeguards to protect LPs:
Overcollateralization
Traders’ positions are always overcollateralized, ensuring that the pool can recover the liquidity provided to traders. In cases where traders’ positions fall below the maintenance margin level, their positions are liquidated. When this happens, the collateral, minus any applicable fees, is returned to the pool, safeguarding LPs from liquidity deficits.
Insurance Fund
The Marginal insurance fund is another key protective measure. By holding passive reserves of X and Y tokens, it ensures that if a trader’s position suffers significant losses, the pool still maintains liquidity. The insurance mechanism compensates for any potential shortfall, ensuring LPs don’t lose their initial liquidity contribution.
Time-Weighted Price Protection
The Marginal platform also uses a time-weighted average price (TWAP) to protect against sudden price spikes or drops. This ensures that the debt traders owe on their positions remains manageable and that positions can be settled in a timely manner without causing liquidity disruptions. Additionally, this structure discourages arbitrageurs from draining the pool, as higher utilization increases the funding rates, pushing traders to settle their positions sooner.
Provide Liquidity on Marginal
Marginal offers LPs a new opportunity to earn more fees from passively pooled liquidity while benefiting from a range of protective measures.
With built-in overcollateralization, insurance reserves, and an efficient liquidation system, LPs are shielded from the major risks that can affect liquidity providers on other platforms, all while earning extra yield on their assets.