Market Risk

Beyond impermanent loss, liquidity providers face broader market risks, especially when exiting positions before maturity.

Composition Risk of Early Withdrawals

When you withdraw from a liquidity pool, you receive a mix of the two pool assets based on the current pool ratio. This ratio shifts over time due to trading activity and price movements:

• If PT prices have fallen relative to the underlying asset since your deposit, you'll receive proportionally more PTs and less of the underlying asset

• If PT prices have risen relative to the underlying asset, you'll receive proportionally less PTs and more of the underlying asset

This means the asset composition you withdraw can differ significantly from what you deposited, creating exposure to relative value changes between these assets after withdrawal.

Time-Dependent Risk Profile

The market risk for liquidity providers follows a distinctive time pattern:

• Higher risk early in the pool lifecycle: During the initial period, interest rate volatility and market sentiment can cause significant PT price movements

• Decreasing risk as maturity approaches: As the PT convergence mechanism strengthens near maturity, price volatility typically decreases

• Minimal risk at maturity: At the maturity date, the conversion ratio becomes fixed as PT equals its face value

This time-dependent risk profile creates natural incentives for providing liquidity over longer periods, particularly those approaching maturity.

Pool Utilization Dynamics

Market risk is also affected by how actively the pool is used:

• Highly active pools with substantial trading volume typically experience more frequent rebalancing, potentially leading to greater asset composition changes over time

• Less active pools may maintain more stable asset ratios but offer lower fee generation opportunities

This creates a relationship between pool activity levels and the stability of withdrawn asset compositions.

Risk Management Strategies for Liquidity Providers

Given these risk factors, liquidity providers can employ several strategies to optimize their experience:

For Managing Market Risk:

• Be strategic about entry and exit timing, recognizing the declining risk profile as maturity approaches

• Consider smaller, gradual entries rather than large lump-sum deposits when pools are new

• When exiting before maturity, consider the implications of receiving a different asset mix than deposited

• Monitor pool metrics like depth, volume, and fee generation to assess ongoing risk-return profiles

By understanding these dynamics and employing appropriate risk management strategies, liquidity providers can make more informed decisions about how yield tokenization pools might fit within their broader investment approach.