Liquidity Provision
Providing liquidity to the Kodiak DEX.
Providing liquidity comes with the risk of impermanent loss, which occurs when the value of tokens in a liquidity pool diverges from holding those tokens directly in one's wallet due to price changes.
The Kodiak DEX enables users to provide liquidity to the protocol and earn trading fees. Users have the flexibility in providing liquidity on the DEX in the following ways:
Islands (Auto-Managed) Liquidity
Depositing liquidity into one of Kodiak's Islands represents is the most straightforward method for contributing liquidity on the Kodiak DEX. These Islands are automated liquidity management vaults with predefined rules tailored for V3 liquidity. These rules are designed to establish optimal ranges for a given Island's token pair and systematically rebalance liquidity to ensure that it consistently remains in-range.
Providing V3 custom liquidity (see below) offers Liquidity Providers (LPs) with more autonomy in managing their concentrated liquidity. However, it involves labor-intensive efforts, requiring LPs to continuously monitor and manually adjust their positions based on their strategies. Additionally, with V3 custom liquidity positions, LPs earn fees solely for trades within their chosen tick range. If prices move outside this range, their liquidity stops earning fees until prices return inside the selected range or LPs manually readjust their tick ranges. On the contrary, Island LPs continuously earn trading fees while still benefiting from the fee efficiency of concentrated liquidity since Islands are designed to keep liquidity always in-range.
For more details on Kodiak Islands, head over to the Islands section.
V3 (Concentrated) Liquidity
The Kodiak V3 AMM, based on Uniswap V3, provides users with the ability to create V3 (concentrated) liquidity positions for a token pair. These positions focus liquidity on a specific price range, represented by ticks. By concentrating liquidity within two ticks, Liquidity Providers can capture more trading fees when swaps occur within that range and potentially mitigate impermanent loss risk compared to providing V2 (full-range) liquidity.
When users create V3 liquidity positions, they receive an ERC-721 Non-Fungible Token (NFT) as a receipt token. This NFT position contains information about the price range that the liquidity is concentrated in, the amount of each token contributed, the fee tier selected for the provided liquidity and other parameters specific to the liquidity provision. For each token pair, distinct liquidity pools exist for each of the unique fee tiers where liquidity is deployed.
The NFT position serves as a distinct receipt token, enabling LPs to effectively manage and monitor their specific liquidity contribution within the pool. For each V3 liquidity position, the LP can also choose to increase or remove (all or a portion) of their liquidity. When liquidity is removed, the LP will also automatically claim the accrued trading fees proportionate to the liquidity withdrawal amount. Accumulated fees can also be manually claimed without removing liquidity.
V2 (Full-Range) Liquidity
The Kodiak V2 AMM, based on Uniswap V2, allows users to provide an equal value of two tokens to a liquidity pool. Unlike V3 liquidity,
For V2 liquidity, liquidity positions are represented as shares of the liquidity pool. When a liquidity provider contributes to a V2 liquidity pool, they receive ERC-20 LP tokens representing their proportional ownership of that specific pool. These LP tokens serve as a proof of ownership in the pool's liquidity.
V2 liquidity providers do not need to manually claim fees. Instead, fees are automatically accrued and added to the liquidity pool over time. As trades occur within the liquidity pool, a portion of the trading fees is distributed proportionally among liquidity providers based on their share of the liquidity provided. This process continuously compounds, increasing the LP's holdings in the pool, including their earned fees, all while remaining within the pool's liquidity.
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