Last week I wrote an overview of the basics of DeFi and yield farming, today we’re going to take a deeper dive and look at some of the more advanced strategies you can employ to earn yield.
I highly encourage reading last week’s Letter if you haven’t yet, even if you think you know the basics — it’s a good primer that discusses the main risks involved and offers several solid options for generating yield for all portfolio sizes.
This is an enormous topic and so I might have to do a Part 3. There’s just so much to cover, and I really want to do this justice. Today we’re going to focus on providing liquidity and the evolution of liquidity pools (LPs) plus talk about some of the more sophisticated strategies you can employ that will make your money work more for you.
Next week we’ll look at the even more exotic things like yield trading (Pendle), looping, leveraging, and delta-neutral farming.
Topic list for today:
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Overall philosophy
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The history and evolution of DeFi and liquidity pools
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Concentrated & single sided vs full-range liquidity
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What is impermanent loss and how does it work?
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Strategies for providing concentrated and single-sided liquidity
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Closing Thoughts
My personal philosophy when utilizing DeFi is less is more. I have been in crypto full time since 2021, and I still find many areas of DeFi to be complex and confusing. Partially because it is, and partially because there are always new protocols and primitives being experimented with and coming to market.
My view is that unless crypto is your full time profession, you should probably not engage in complex DeFi activity. Stick to the simple things, or at least, stick to one or two areas that you are comfortable with, and avoid getting caught up in trying “the hot new thing” in order to eek out a few extra % of yield.
The areas of DeFi I personally use the most are providing concentrated and single-sided liquidity, and even then, I only generally have a couple of positions open at any given time. The more positions, the riskier it gets, and the more time is needed to manage everything.
My advice is to take things slow and keep things simple until you really understand what you’re doing. Dabble and experiment with small amounts of money to get an idea for how it all works in practice before putting a significant percent of your bankroll in.
And always remember the golden rule of DeFi:
If you can’t explain the yield, chances are, you are the yield.
In 2017, Vitalik wrote a blog post that introduced the concept of AMMs: Automatic Market Makers. These would become a central pillar in decentralized exchanges, and indeed, it wasn’t long after that we saw the first dApp utilizing AMMs: Uniswap.
It would be hard to argue that there is any more influential DEX than Uniswap. It has been forked countless times and has inspired countless more, serving as a building block for many, many other DeFi protocols. So let’s have a quick look at the history of Uniswap and how things have evolved.
Uniswap launched in 2018 with their V1 product which replaced the traditional order book model of centralized exchanges (and even earlier decentralized ones) with the liquidity pool model. The concept was simple:
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Anyone could deposit two assets with a 50/50 ratio into a liquidity pool
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Traders would then swap against that pool
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The depositors (aka liquidity providers, aka LPs) would earn fees
Brilliant, albeit extremely simplistic and limited in features compared to where they are today.
Uniswap then launched their V2 in 2020, arguably kicking off what is known as DeFi Summer, but it was their V3 launch in 2021 that to me was the greatest unlock. Up until then, liquidity providers could only deposit assets in an equal 50/50 ratio and cover the entire range of prices. With V3, users could now select the price range they wanted their liquidity to cover, allowing for significantly greater capital efficiency.
They launched their v4 at the beginning of 2025, and to be perfectly honest, I still don’t fully understand all of it! What I do understand though is that it unlocks an insane amount of customizability, allowing developers to create their own “hooks” (apps/plugins) to allow for things like limit orders, dollar-cost-average strategies, auto-compounding, dynamic fees, and more.
Some of the innovation we’ve seen beyond Uniswap is equally remarkable. While Uniswap pioneered AMMs, Meteora, a DEX on Solana, has pioneered DLMMs: Dynamic Liquidity Market Makers. We’ll look at this more in the last section of this post.
As I mentioned, I think the greatest unlock came with V3 of Uniswap and the concept of concentrated liquidity. Let me explain exactly what this means and how this works in practice.
In a uniswap V2 liquidity pool, when you provide liquidity, your tokens are spread across the entire possible price range (from $0 to infinity). This means that most of your liquidity is sitting unused if the token price trades in a narrow band.
For example, you create a liquidity pool for ETH/USDC and ETH trades between $3,300–$3,800. Under a V2 liquidity pool, your funds are also “covering” ETH at $50 or $100,000 just in case the price gets there and someone needs liquidity to swap. Obviously, the chances of ETH going to $50 or $100k any time soon are virtually 0%, so the capital being used to cover those amounts is being utilized inefficiently.
Concentrated liquidity (Uniswap V3 and similar) changes this.
Under this version, liquidity providers can now choose a custom price range that they want to provide liquidity for, and deposit funds to cover just that range.
The downside is that they will only earn fees while the market trades within that range, and the impermanent loss can be a lot more significant (more on this in the next section).
The upside however is that the fees earned can be significantly higher, since all of your funds are now being utilized across a smaller range.
It’s not that V3 is a strictly better model than V2 in all instances, it’s that it allows for infinitely more optionality. You now have the choice to cover the whole range, or only part of it, or — and this is one of my favourite ones — only one side of it.
Your ratio can be whatever you want, 50/50, 80/20, or, yes, 100/0. Why might you want to do this? We’ll cover some specific strategies in the final section of this post, but the tldr is that single sided liquidity allows you to effectively dollar cost average in or out of positions while earning fees at the same time.
It’s just a little bit magical once you get the hang of it.
When you provide liquidity to a liquidity pool (LP), you generally deposit two tokens. Often this is done in a 50/50 ratio of the value of the tokens, and for the purposes of this explanation, we’ll use a 50/50 ratio to keep things simple, and also assume that your LP covers the whole price range.
If one token’s price changes relative to the other, the LP automatically rebalances, meaning that the quantity of one token goes up and the other goes down, to ensure an equal amount of both remain in the pool.
When this happens, you are often left with less total value than if had simply held the tokens.
That loss in value is called impermanent loss.
It’s called impermanent because the pool is constantly shifting and can also rebalance in the other direction. Once you withdraw your position, it becomes a permanent loss.
Confused? Don’t worry, it took me a while to figure this out too. I find examples are helpful, so let’s look at a basic one:
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You deposit 1 ETH ($3,500) and 3,500 USDC into a liquidity pool
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Your total deposit is therefore $7,000
The price of ETH then doubles to $7,000.
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If you’d simply held all your tokens you’d now have $10,500 ($7000 in ETH + $3500 in USDC)
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In the liquidity pool however, you end up with less ETH and more USDC. This is because as the price of ETH has been going up, people have been buying ETH, meaning that you’re losing some of your ETH and receiving some USDC for it
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In this specific example, you would end up with a combination of ETH & USDC worth only ~$9,898.
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Therefore your impermanent loss is roughly –5.7% relative to holding.
If you want to know how the math behind this works, I refer you to the Uniswap Docs and their constant product formula, a price curve defined by x*y=k where x and y are the prices of the tokens in the pool, and k is a constant.
If you’re like me however and slightly complex math makes your brain hurt and you like taking shortcuts in life, then I refer you to this wonderful calculator for working out your impermanent loss!
You can see in the image below, I plugged in the above example, and it spat out the impermanent loss figure of 5.72%.
This doesn’t mean it’s a bad idea to do this — it just means that in order for this to be a profitable scenario, you will have needed to earn more than 5.7% in fees/yield to offset the impermanent loss.
Actually, it’s a bit more complex than that — since you’re not necessarily comparing opening a liquidity position vs doing nothing. You ought to compare your liquidity position to whatever else you could be doing with the funds, aka earning 2-3% yield on your ETH or 5-15% yield on your USDC.
Hopefully you have a basic understanding of how impermanent loss works now.
The same concept applies to concentrated and single-sided liquidity pools too, albeit with more complicated math and formulas working in the background.
Once again, I prefer shortcuts, and have discovered another wonderful calculator which not only shows you your potential impermanent loss, but also the amount of fees you would need to earn in order to offset that loss.
I plugged in an example once again using $7000 of liquidity, but this time I added it to a concentrated range of $3300 – $3800. Then I looked at what would happen if the price of ETH went to $5000. The impermanent loss is 13.97%. Which seems bad, right?
But if you look at the fees earned, you can see the power of concentrated liquidity. After 30 days of having this position open, the impermanent loss is entirely offset by the yield. If we keep it running longer, the yield keeps adding up.
The more volatile the asset, the greater the impermanent loss is likely to be, so keep that in mind.
I know this was a lot of info, and it genuinely does take a while to wrap your head around. As I mentioned at the top, the best advice I can give is to get your hands dirty and just try this out for yourself. Start with extremely small amounts of money — you can do it with a few dollars on Base chain or somewhere with negligible gas fees, and start to get a feel for how it works.