Introducing GM Vaults — The New Era of Liquidity Provision on Arbitrum

Umami
10 min readDec 7, 2023

The launch of Umami’s GLP vaults in July marked a significant shift in the DeFi landscape, showcasing the effectiveness of our unique strategy despite performance fluctuations and the challenges posed by the OI skew in GLP. GLP vaults successfully achieved delta-neutral positions, a previously unattainable feat, offering a single-sided solution to liquidity providers and, in some cases, even outperforming GLP itself.

The release of GMX’s v2 platform in August introduced several critical improvements, most notably addressing the open interest skew issue, which had been a major constraint for both GLP and our GLP vaults, making both products somewhat bearish in nature — good hedging tools but not ideal in an overall bullish market.

They will offer a single-sided solution with no impermanent loss as well, enhanced by the vaults’ high scalability and the composability of the vault tokens, which means they can act as versatile building blocks for other DeFi protocols.

This positions the vaults to revolutionize liquidity provision for GMX and serve as a pivotal liquidity hub on Arbitrum.

Let’s delve deeper into the details of the development of GM vaults, examining their unique features and mechanisms, and exploring how they improve upon the GLP vaults.

The GLP Vaults: A Stronghold in Bear Markets

Centered around the $GLP token — an index of USDC, BTC, ETH, LINK, and UNI — Umami’s GLP vaults uniquely offer single-sided exposure to these assets with no impermanent loss, while still earning GLP yield. Being built on top of the GLP, these vaults also serve as a counterparty to GMX traders, thereby intricately linking their performance to the fluctuating profit and loss (PnL) of traders on the GMX platform. In scenarios where the market trends downwards, GLP vaults have historically thrived, capitalizing on the GMX permabulls’ net-long positions losing out as the markets slump.

However, the GLP model encounters challenges in ‘up only’ market conditions. The absence of the balancing force of (negative) funding rates and reliance solely on borrow fees, almost always results in a large positive open interest (OI) skew, exposing liquidity providers to increased risks during bullish markets. While robust in many aspects, this becomes a short term limitation for GLP vaults in a persistently rising market.

Despite these challenges, our GLP vaults have proven their effectiveness by achieving a delta-neutral position — a notable achievement still unmatched by others. In recent months, some of these vaults have even outperformed the GLP itself, highlighting their robustness and ability to fulfill their intended purpose.

It’s also important to note the effectiveness of the vaults’ Internal Netting mechanism, which has been working flawlessly, efficiently hedging a TVL of $5.8 million with only $62k in external positions, therefore achieving delta-neutral positions at an exceptionally low cost.

Fig 1: GLP vault have been successfully hedging $5.8M with only $64k in ext. hedges

(GMX v2) GM Vaults: A Leap Towards Market Neutrality

As the DeFi ecosystem continues to grow and evolve, so do the strategies and tools designed to navigate its complexities. Umami’s GM vaults represent this evolution, building on the success of GMX v2, these vaults are designed to offer a more balanced and adaptable solution for liquidity providers.

Technological Enhancements in GM Vaults

What kind of improvements can users expect in the GM vaults? Below, we detail the 3 key enhancements that mark a significant progression in liquidity provision, addressing the challenges faced by GLP vaults and reducing the cost, and providing a better yield in any market conditions.

  • Chainlink’s Low-Latency Oracle: The GM Vaults will leverage Chainlink’s Low-Latency Oracle solution, bringing more accurate and timely trading decisions, which will enhance gas efficiency, and reduce operational costs. This technological leap allows for a substantial reduction in deposit and withdrawal fees, making these vaults even more accessible and efficient.
  • Open Interest Skew: One of the notable enhancements in GMX v2 is the implementation of adaptive funding rates across all pools. This development has had a profound impact on balancing the Long:Short dominance within the pools, significantly shifting the skew towards a 50:50 equilibrium, as demonstrated in the chart below (Fig 2, after blue dotted line). This achievement translates to a more favorable environment for liquidity providers, offering reduced exposure to trader profit and loss (PnL). These adaptive funding rates, determined by open interest, act as a stabilizing force, playing a pivotal role in maintaining the neutrality of GM vaults to market movements. This not only bolsters the overall efficiency of GMX v2 but also aligns with the risk-adjusted index approach embraced by the vaults.
  • Isolated Liquidity Pools: GMX v2 features isolated liquidity pools, offering LPs the choice to select specific asset pairs for liquidity provision. This approach contrasts with the GLP model’s exposure to a basket of assets, providing LPs with more control and reduced risk.
Fig 2: Adaptive funding rates have a profound impact on shifting the skew towards a 50:50 equilibrium

Strategy

GM vaults employ a simple but powerful strategy. Liquidity is deposited into a risk adjusted index of GM pools (GMI), which form the core of the vaults’ operation. To maintain balance and stability in their asset allocation, GM vaults rely on internal netting; a unique and extremely efficient hedging mechanism, developed by the Umami team. The strategy is executed trustlessly by an advanced, distributed network of companion bots that act in a reliable and redundant manner, within the strict and immutable bounds of the on-chain constraints.
Notably, this internal hedging mechanism is being utilized by the GLP vaults, that have impressively been hedging millions of dollars of TVL with just tens of thousands of dollars of collateral (Fig 1), therefore achieving delta-neutral positions at an exceptionally low cost.

At launch, GM vaults will focus on GM markets backed by ETH and USDC only, we call it GMI (GM Index).

They’ll monitor LP position deltas, allocate assets optimally, and employ an efficient rebalancing process. The rebalancing, initiated on a multi-hourly basis, will ensure that assets remain in their optimized state at an extremely low cost.

GMI (GM Index)

Fig 3: The vaults will be gathering liquidation fees, swap fees, and PnL from all four markets.

The initial ETH and USDC vaults will have exposure to 4 markets (Fig 3):

  • ETH-USDC
  • XRP-USDC
  • DOGE-USDC
  • LTC-USDC

This approach allows the vaults to maximize revenue by gathering liquidation fees, swap fees, and PnL from all four pairs, ensuring a balanced risk-adjusted return across these ETH and USDC backed markets.

When a user deposits ETH, they become the counterparty to traders involved in trading those pairs. However, our underlying infrastructure, composed of Internal Netting and an external trading router, ensures that users receive the delta of ETH in the ETH GM vault while maintaining delta neutrality for USDC.

Asset allocations are initially set with static weights, determined by considering factors such as asset volatility, realized returns, trading volumes, and liquidity. This approach aims to create a favorable balance between expected returns and volatility.

It’s crucial to note that GMX V2 utilizes ETH to collateralize their markets. Consequently, if a token sharply outperforms ETH in a brief period, GMX may decide to close that market due to it being undercollateralized. The immediate impact of this mechanism is the limitation of the overall profit and loss (PnL) potential to which the index is exposed.

In essence, this is a strategic approach designed to mitigate risk, effectively placing a cap on potential gains or losses. When using perpetual contracts in this system, users take on a position that has certain implications similar to specific financial instruments, but we’ve kept the details straightforward for clarity.

In the weeks following the launch, we will expand GM vaults’ exposure to additional markets backed by other tokens, increasing the breadth of choice for users looking to enjoy the benefits of the vaults.

Following the launch of GLP vaults, we saw first hand the high demand for yield sources for WBTC. Consequently, WBTC vault development will be our initial priority in this period.

The development of these additional vaults will be expedited based on demand, and due to the configurable and modular nature of the smart contracts, can be rolled out at a relatively quick pace.

A Comparative Analysis: GLP vs. GM Vaults

When evaluating and comparing GLP and GMX v2 GM pools, we can see significant differences that shape their roles in the Arbitrum’s DeFi ecosystem. A detailed look at the recent data highlights these distinctions and our understanding of why the development of GM vaults was necessary and why we are very excited about it.

TVL, Volume, and Fees

Fig 5: Volume comparison between GMX v1 (GLP) and GMX v2 (GM)

Arbitrum’s STIP catalyzed a notable rise in TVL for GMX v2, catapulting it from $87M to an impressive $200M in the last few weeks. This upswing is a testament to the LP improvements of GMX v2, bolstered by the GMX team’s strategic use of $ARB from the STIP to subsidize deposit fees, for those pivoting and moving their liquidity from GLP to v2 (Fig 5).

While GLP maintains a formidable TVL of $280M, the increased utility of v2 is very apparent, with its volume trajectory scaling new heights post-STIP. The v2 platform’s fee generation has reached a cumulative $6B, with recent weekly fee collections outstripping those of v1 (Fig 6), indicative of the traders’ move from v1 to v2 which is also prioritized by GMX’s front end.

Fig 6: GMX v2 has overtaken v1 in weekly accumulated fees

Open Interest Skew and Traders PnL

Fig 7: GMX v2 has a more equal distribution between long and short positions

The GMX v2 platform’s strategy has successfully mitigated the imbalances seen in open interest skew, presenting a more equal distribution between long and short positions. This is highlighted by the numbers post-STIP, where we saw a shift from a predominantly long-dominant market to a healthier balance, aiming towards the ideal 50:50 equilibrium.

The impact of this on liquidity providers is substantial; a balanced open interest means reduced directional bias, which translates to lower risk during market fluctuations.

In terms of traders’ profitability, the charts reflect a considerable divergence between v1 and v2. While v1 has observed traders securing $8M in PnL from $16M in fees, effectively reducing the yield for liquidity providers by 50%, v2 tells a different story. With $4.65M in fees and traders’ PnL at about $1M, the impact on liquidity providers’ yield is significantly lower, at roughly 21.51%. This demonstrates a more sustainable model in v2 where traders’ performance has a less pronounced effect on the overall fees, preserving more of the yield for liquidity providers.

Fig 8: Even with the adaptive funding fee update implemented only a few weeks ago, GMX v2 still shows a lower PnL impact on yield than GMX v1 since August, at 21.51% vs 50% respectively.

The charts reinforce the narrative that GM vaults, by virtue of their design and the underlying mechanics of GMX v2, provide a fortified position against the volatility and bias that can affect liquidity provider returns.

Security and Audit Measures

Taking a security-centric approach is paramount for the GM vaults. Rigorous testing, and an internal audit is already underway to identify and rectify any potential vulnerabilities in the code before submission to a more formal external audit scheduled with Guardian on December 11th to ensure the highest standards of security. Guardian stand out as the perfect auditor, having already audited the GMX v2 codebase, providing them with a valuable oversight of its intricacies and nuances. Common security measures, such as multi-signature wallets, time-locks for major protocol changes, and continuous monitoring for unusual activity, are integral parts of our security framework. These precautions, coupled with the community’s vigilance, fortify the GM vaults against potential threats, ensuring a secure DeFi environment for our users. An asynchronous and rate-limited withdrawal mechanism also acts as a loss-limiting circuit breaker should the unthinkable happen, limiting potential damages from an exploit to just a small fraction of the overall TVL.

Testing and Development Process

In preparation for the launch, extensive testing of the GM vaults is scheduled with the treasury at the end of the year. Prior to the audit, we will be rebalancing to ensure the solidity of the code and its effective functionality. Following the audit, our focus will shift to improving the Keeper mechanisms until later in December, at which point we plan to run the vaults with real funds. This phased and meticulous testing approach ensures that every aspect of the GM vaults is optimized for performance and security.

Composability, Integrations and Scalability

Our GM vaults are set to make a significant impact in the DeFi sector, driven by the composability of our GM tokens. These tokens are not just assets; they can be used as dynamic building blocks designed to integrate seamlessly within various DeFi protocols.

This intrinsic quality of composability, combined directly with the ability to offer single-sided exposure to liquidity on GMX v2, catapults the GM vaults beyond their existing counterparts, positioning them as potential liquidity hubs on Arbitrum.

Our vaults are also designed for high scalability, which means they can easily adapt and integrate into multiple protocols, enhancing our ability to form versatile partnerships across the DeFi space, particularly with entities already aligned with the GMX v2 ecosystem.

A noteworthy partnership on the horizon is with Dolomite, a prominent lending platform. This collaboration plans to integrate our tokens from both GLP vaults and GM vaults soon after our launch.

Conclusion

GLP and our GLP vaults have established themselves as robust performers in bear markets and effective hedging tools in bull markets.

However, the forthcoming GM vaults represent a significant advancement, tailored to excel in all market conditions.

This versatility makes the GM vaults particularly suitable for long-term investment strategies with major assets like ETH, BTC, and USDC, allowing users to leverage the benefits of GMX v2 yields more effectively, especially in light of the upcoming grants from Arbitrum.

The GM vaults’ innovation lies in their streamlined investment process, enabling users to engage in liquidity provision without the complexities of hedging strategies.

This simplicity, combined with our strategic alliances within the GMX v2 infrastructure, amplifies our potential and solidifies the GM vaults as a substantial progression in the DeFi space. They are poised not only to enhance the Arbitrum and GMX ecosystem but to redefine liquidity provision as we know it.

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