DeXe Investment: What are LP and LP2 tokens?

LP tokens in DeXe Investment are a bit different from the LP tokens you’re used to hearing about in the past few years, but not by that much.

Classic LP

In classic DeFi, LP stands for Liquidity Provider tokens, usually referring to a token representing a specific pair on an AMM such as ETH-USDC or DEXE-BUSD. Depending on the AMM, the liquidity provider adds the tokens 50–50 or in some other proportion and receives a number of LP tokens proportionate to his share of the liquidity pool. Even while the balance of tokens in the pool is balanced with the shifts in prices of each crypto in the pair, the number of LP tokens the liquidity provider holds remains the same.

LP in DeXe Investment

In a way, investors are providing liquidity to a fund on our platform. But that liquidity is not necessarily a single trading pair since a fund can have any number of assets in it at any given time (with the caveat that all trading must be done as a pair with the Base Asset chosen by the trader when creating the fund).

There is no need to provide liquidity for pairs in our funds because all the trading is done by one person (the fund’s trader). New funds can be distributed proportionally to the assets already in the fund at the time of entry (e.g. 30% ETH, 20% DEXE, 50% USDC).

Regardless of the distribution, the profit is calculated relative to the price of the base asset (easy if the base asset is a stablecoin like USDC). When new liquidity is added by an investor, the trader has more money to trade with and new LP tokens are created for this new investment. Thus the number of LP tokens increases but so does the capital invested, i.e. the proportion of LP tokens to capital remains unchanged. When an investor wants to cash out the LP tokens, they are burned and the investor receives the base asset in proportion to his LP percentage of all LP tokens in the fund.

What’s LP2?

LP2 is relevant once a trader creates a Risk Proposal, which trades separately from the base fund and where the trader can trade his base asset (the one selected when the original fund was created) for any token at all — not restricted to the whitelist (hence, the risk). The trade creates this risk proposal by depositing some of his LP tokens from the main fund.

Since there is a limited number of LP tokens and since this is a riskier investment, the investors can only invest up to the same % of their LP tokens as did the trader. So if a trader has 1000 LP and invests 100, each investor can only invest 10% of her LP tokens.

The investor then receives LP2 tokens that are valid only for this risk proposal (while their invested LP tokens are burned). If the investor wants to cash out, the LP2 tokens are burned and the investor receives the fund’s regular LP tokens for them.

Note: When cashing out of LP2 into LP, the investor will receive the LP tokens at their current price at the moment when she burns LP2 not at their price at the time she opened her L2 position. For example: If each LP token was worth $1 when the risk proposal was created but is worth $1.50 when an investor wants to cash out (50% gain), an investor that used 500 LP to buy LP2 would now be able to only buy 333LP. But if the LP2 made a 100% profit during that time, the investor has $1,000 to buy the LP with, hence will buy 667 LP tokens.

As you can deduce from this, it is to the investor’s advantage for the LP2 to be profitable while the regular LP takes a loss. Overall, there are a number of strategies as to when to buy/sell the LP, the LP2, and which LP2s to participate in (with consideration of the investor’s risk appetite, investment style, interest in specific base asset trading, etc.). And for the trader, having a general fund with LP and an unlimited number of specifc risk proposal with LP2 allows for greater flexibility while still maintaining accountability and focus.

Stay tuned!

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