Introducing LSPs

TL;DR LSPs are tokens that represent a share in an automated, leveraged position. The long token is any asset that can be collateralised. In contrast, the short token can be almost anything else. A simple example of this is a token that represents a view that Ether will outperform Bitcoin and levers Ether against Bitcoin in some ratio.

What is an LSP?

LSP stands for Long-Short Pair and is a token that represents a share of an underlying leveraged position. It is the first product of the levl.ly DAO that we will soon start building.

LSPs allow an investor or speculator to enter complex leveraged positions which might represent broader beliefs they hold about the direction of the market. For instance: If a trader believes that Bitcoin will outperform Ether and do so in part by draining value from Ether’s price, they can construct an LSP that longs Bitcoin against Ether in some ratio. This position becomes fungible, allowing others to enter it as well. LSPs can facilitate this view, or the inverse and allow liquidity providers holding LSPs to earn additional fees. LSPs are great for medium-term directional trade where people don’t want to worry about managing leverage themselves.

LSPs build on the DeFi legos of loan markets, leverage, AMMs, leverage management automation, tokenization and liquidity provision fees.

Loan markets, leverage and AMMs

At their very base, LSPs use Loan markets to deposit the long side of the trade as collateral and borrow the short side of the trade as debt. By way of example, we could deposit Ether into AAVE, borrow BTC, sell the BTC for more Ether on an AMM, and then redeposit the Ether as collateral. This kind of position is done quite routinely in DeFi. The challenge is that its position can be margin-called by AAVE, leading to unnecessary losses in positions that might likely have recovered.

Leverage management automation

Leverage is not for the faint-hearted or the unprepared. Leverage automation allows the leveraged position to stay within a certain range of leverage. For instance, an LSP is created to give 3x exposure in favour of Ether against BTC. The LSP can be configured to rebalance itself if it either goes below 2.8x leverage or above 3.2x leverage. If it moves above 3.2x leverage, it will borrow more BTC, sell it for Ether and add the Ether back to the position. In contrast, if the LSP moves below 2.8x leverage, it will sell some Ether, trade that for BTC and pay off some of the BTC debt.

LSPs will accomplish this through market incentives for arbitrage bots to execute the trades on behalf of the LSPs. We will publish a future article that will describe this design.

Tokenization and liquidity provision fees.

LSPs can be created by anyone in a wide variety of token combinations and leverage configurations. The positions are then tokenized into standard ERC20 tokens to allow them to be traded in on other platforms or to be used as DeFi legos.

A further benefit of LSPs is that they can be configured to provide liquidity fees for their holders. The reason this is possible and reasonable is that there are costs associated with the rebalancing process of these positions and people entering or exiting the positions make those rebalances more likely. It should also be possible in future for LSPs to allow their reserves to be used as AMMs and through that mechanism generate yet more fees for the holders.

Who LSPs are built for?

A common internal team saying is that LSPs are meant so that “everyone can be Michael Burry”. For those unfamiliar, Michael Burry is the legendary investor who had banks create a bespoke financial product in order for him to short the US mortgage market. “The Big Short” movie tells the story in more detail. Using LSPs, products such as the one described in the movie can regularly be created. They allow clever market participants to create easy to understand tokens that represent their positions.

LSPs would ideally be used either for sustained trends in certain markets, such as an extended bull market, lengthy bear market or for playing impulse moves. An example of this is capitalizing on a very steep recent dip and then selling on the recovery.

LSPs would likely also work well when correctly paired in AMMs, with their underlying assets types to farm the volatility in a ranging market.

What are the associated fees?

A protocol fee of 0.5% for entering and exiting an LSP is changed, which goes to the levr.ly DAO for further development of the ecosystem.

The creator of an LSP can set an automation fee that is paid by people entering or exiting an LSP. This is to compensate for carrying the associated costs of having kept open the LSP by providing liquidity. Additional costs might also be triggered by an entering participant. This is because the target leverage ratio might be moved.

At this stage, no creator fee (beyond the automation fee) is planned. We’re also not planning a streaming fee. This makes our positions comparatively non-extractive.

Where can I try it?

The generic version of LSPs is currently being built, however, you can try a live, initial concept version already built, called dEth. Head over to app.levr.ly and check it out.

To find out more about our product, head over to https://levr.ly

levr.ly is a member-managed DAO aimed at constructing automated, efficient leverage products for all.