A51 Finance: A Detailed Guide on Market Modes
This article explains the four Market Modes available to LPs in A51. A51 comes with four market modes for you to choose from:
Each of these modes is designed to facilitate a particular kind of liquidity strategy to keep your liquidity active according to certain parameters.
All liquidity-shifting is performed by the A51 smart contracts. Liquidity is moved based on the Time Weighted Average Price (TWAP) in a pool.
Let’s take a closer look at each of the modes in turn.
Bull Mode
This mode acts like a dynamic range order that tracks price increases in a pool. It’s effective when there’s a rise in demand for the base asset in a pool, causing its price to increase. LPs in Bull mode benefit from upward price movements by using the quote asset to gain from the rising value of the base asset. The mode automatically adjusts LPs’ liquidity to the right on the liquidity graph, aligning with price increases and generating fees while minimizing impermanent loss.
Consider an ABC-XYZ pool, where XYZ is the base asset on the right side of the liquidity graph and ABC is the quote asset on the left. In scenarios where XYZ is performing strongly, it’s likely that more traders will exchange ABC for XYZ. This trading activity alters the ABC to XYZ ratio, leading to a rightward shift in the price line on the chart as the Automated Market Maker (AMM) adjusts the price of XYZ upwards (meaning more ABC is needed to purchase XYZ).
Bull mode is specifically tailored to track upward price movements, enabling Liquidity Providers (LPs) to leverage a proactive liquidity strategy that capitalizes on rising prices.
In short, an LP in Bull mode utilizes the quote asset (on the left) to gain from the appreciation of the base asset (on the right).
Let’s revisit the ABC-XYZ pool scenario. Imagine an LP has chosen Bull mode with a position predominantly in ABC, located to the left of the currently active ticks. If XYZ experiences a surge in value, traders will exchange ABC for XYZ, eventually depleting the XYZ in the current active ticks. This causes the price to shift rightward into the next ticks, now filled with XYZ.
A51 then reallocates the LP’s liquidity one tick to the right, to the previously active tick. This tick, now fully stocked with ABC, blends seamlessly with the LP’s existing ABC holdings. The LP’s position is thus reoriented to the tick just left of the active one.
The strategy aims to earn fees for the LP while minimizing impermanent loss. Essentially, Bull mode allows an LP to speculate on the rise of one asset against another. If their prediction is accurate, they can trail the price rightward, collecting fees along the way.
This approach depends on the non-linear nature of price movements. Token pair prices undergo numerous minor adjustments even as they trend in a clear direction, influenced by market dynamics and arbitrage. Despite a general rightward trend, the price often dips back left due to market corrections or arbitrage, generating trading fees for the LP. With exposure primarily to one asset, the LP’s risk of impermanent loss is reduced.
Continuing with our example, the LP’s holdings are now repositioned to the left of the current active tick. Although the price trends rightward, arbitrage realities suggest that traders will keep selling XYZ to the pool whenever its price deviates from the broader market. Incoming XYZ is exchanged for ABC from the LP’s tick, generating fees. The newly acquired XYZ in the LP’s tick becomes the first to be sold to traders, creating additional revenue.
It’s important to recognize that Bull mode doesn’t guarantee returns; it’s a tool to automate a specific active liquidity strategy for LPs. LPs should independently research and decide on their market strategies. However, those bullish about a particular token can use Bull mode to earn fees without constantly monitoring their liquidity position.
Note that Bull mode is unidirectional. If market trends cause the price to shift leftward, the protocol leaves the LP’s ticks unchanged. This could result in the LP being fully swapped to the underperforming asset (the quote asset on the right), leading to potential impermanent loss.
Bear Mode
Bear mode operates as a dynamic range order that tracks the price movement within a pool, particularly when it shifts left on the liquidity graph. This leftward movement typically signifies a drop in the value of one of the pool’s assets (commonly the “base” asset), often due to increased trading prompted by a fall in demand for that asset. This leads to more traders exchanging this asset for the other in the pool.
In many ways, Bear mode is the opposite of Bull mode: Liquidity Providers (LPs) can place their liquidity in the ticks just to the right of the current active tick, including the active tick itself. This approach is beneficial for LPs who anticipate a decline in the value of the base asset relative to the quote asset, causing an overall leftward price trend. If their predictions are accurate, the price will gradually shift to the left, allowing them to earn fees from the resulting market volatility while keeping impermanent loss to a minimum.
To put it simply, an LP in Bear mode leverages the base asset on the right to gain from the increase in the value of the quote asset on the left. The objective for a Bear mode LP is to maintain a position in the base asset just next to the price line, ready to collect fees when the price momentarily shifts rightward.
Consider, for example, our ABC-XYZ pool scenario, but with an LP who anticipates a downturn in the market value of XYZ. Choosing Bear mode, they add XYZ to the ticks right next to the current active tick. If their prediction comes true and XYZ’s value starts to fall, traders will exchange their XYZ for ABC. As the asset ratio in the pool shifts, A51 adjusts the price leftward, decreasing the amount of ABC given for each XYZ.
When the price exits the active tick to the left, converting it entirely to XYZ, the protocol automatically reallocates the LP’s XYZ into this tick, now positioned right of the new active tick. As the price fluctuates due to market volatility, moving back and forth into these right-side ticks, the LP collects fees from these transactions and can continue to do so as long as the price remains or moves further left.
Similar to Bull mode, Bear mode is unidirectional. If the price trends rightward, the protocol does not adjust the LP’s ticks, potentially leading to a complete swap to the less-performing asset (the left/base asset) and a risk of impermanent loss. It’s important to note that these modes are not a guarantee of returns; they are tools designed to support an LP’s strategy based on their market analysis and predictions.
Dynamic Mode
Dynamic mode operates as a versatile range order that tracks the price movements within a pool, whether it shifts right or left. Unlike Bull and Bear modes, which are directional and move an LP’s liquidity based on price movement in one specific direction, Dynamic mode adapts to both upward and downward price movements.
In Dynamic mode, a Liquidity Provider (LP) can place liquidity in the current active tick or in the ticks immediately adjacent to it, either to the left or right. When trading activity causes the price to shift out of the active tick into new ticks in any direction (for instance, to the right), the LP’s liquidity on the opposite side (in this case, the left) is automatically repositioned into what was the active tick, thus keeping a significant portion of it near the current pool price.
Let’s consider the ABC-XYZ pool as an example. An LP using Dynamic mode might add liquidity to the ticks just left of the current active tick, initially holding entirely ABC.
Should the market value of XYZ rise, traders would exchange ABC for XYZ. Eventually, this activity depletes all XYZ in the current active tick, causing the price to move right into the next tick, predominantly filled with XYZ. The protocol then shifts the LP’s liquidity to the ticks on the left of the active tick, now primarily ABC, mirroring Bull mode’s functionality.
If the price keeps moving in the same direction into new ticks, the protocol continues to adjust the LP’s liquidity accordingly. Conversely, if the price reverses direction (say, from right to left), the protocol allows the LP’s position to be completely swapped before repositioning the liquidity to follow the price from the opposite side (now from the right).
Continuing with our example, if the trend reverses and XYZ’s value starts to decrease, the trading activity will push the price left, out of the current active tick, and into the ticks on the left, where the LP’s liquidity was recently repositioned. This means the LP’s position now includes the current active tick.
As XYZ’s value continues to drop, the price moves through the active tick, swapping all ABC for XYZ, and into the ticks on its left. The LP’s liquidity is now in the ticks to the right of the active tick, consisting entirely of XYZ. If the price keeps trending left and moves into the ticks to the left of the current active tick, A51 will reposition the LP’s XYZ into the tick directly to the right of the new active tick.
Dynamic mode aims to maximize fee collection by keeping the LP’s liquidity concentrated close to the fluctuating price. Whenever the price traverses a tick containing the LP’s liquidity, LPs earn fees.
However, it’s important to note that the risk of impermanent loss in Dynamic mode is higher than in Bull or Bear mode, as the LP is exposed to price movements in both directions. Additionally, there’s a risk of “permanent loss” due to the implicit agreement to sell assets that are underperforming at any given time. Therefore, Dynamic mode involves a considerable level of risk, and users should carefully consider its implications before opting for it.
Static Mode
Static mode, as implied by its name, enables the addition of liquidity without activating any of A51’s liquidity-moving features. This mode functions similarly to a traditional Automated Market Maker (AMM), where a Liquidity Provider (LP) places liquidity into specific ticks, and this liquidity remains fixed in those ticks, irrespective of price fluctuations. Due to its non-reactive nature to price changes, Static mode might not be as capital efficient as the other modes, yet it offers unique opportunities for LPs to apply it according to their specific strategies.
Additionally, Static mode can be integrated with liquidity shape parameters, paving the way for the development of more complex and nuanced strategies. However, the specifics of liquidity shape parameters are beyond the scope of this article and will be addressed in a subsequent discussion.
