Paper: arXiv 2307.03935

Abstract

Liquidity providers are currently incentivised to provide liquidity through the LP Incentives Programme on dYdX. Based on the various parameters - makerVolume, depths and spreads, they are rewarded accordingly based on their activities. Given the maturity of the BTC and ETH markets, alongside other altcoins which enjoy a consistent amount of liquidity, this paper aims to update the formula to encourage more active and efficient liquidity, improving the overall trading experience. In this research, I begin by providing a basic understanding of spread management, before introducing the methodology with the various metrics and conditions. This includes gathering orderbooks on a minute interval and reconstructing the depths based on historical trades to establish an upper bound. I end off by providing recommendations to update the maxSpread parameter and alternative mechanisms/solutions to improve the existing market structures.

Complexity vs Empirical Score

  • Math Complexity: 4.5/10
  • Empirical Rigor: 7.0/10
  • Quadrant: Street Traders — practical and empirical, lighter on theory

Why this score: The paper uses basic statistical metrics and empirical analysis of order book data to propose changes to a live incentive program, with methodology focused on data collection and implementation rather than advanced mathematical theory.

Research Flowchart

  flowchart TD
  A["Research Goal: Update LP Incentive Formula<br>to improve liquidity efficiency"] --> B["Data Collection & Preparation"]
  B --> C["Metric Calculation &<br>Spread Analysis"]
  C --> D["Reconstructing Depths &<br>Establishing Upper Bounds"]
  D --> E["Computational Analysis<br>of Market Conditions"]
  E --> F["Key Findings & Outcomes"]

  B --> B1["Input: Minute-interval<br>Orderbook Data"]
  B --> B2["Input: Historical<br>Trade Data"]

  C --> C1["Metrics:<br>Maker Volume, Depth, Spread"]
  
  E --> E1["Parameter Optimization<br>for BTC/ETH Markets"]
  E --> E2["Altcoin Liquidity<br>Assessment"]

  F --> F1["Recommendation:<br>Update maxSpread Parameter"]
  F --> F2["Proposal:<br>Alternative Incentive Mechanisms"]