Uniswap launches new metric FLAIR! Used to measure competitive dynamics among different liquidity providers

The decentralized market leader Uniswap has launched a new indicator, FLAIR, today. It is designed to measure the competitive relationship among different liquidity providers (LPs) in the liquidity pool. Additionally, it helps LPs review their past performance to adjust their asset allocations.

1/ Introducing FLAIR —a new metric to measure intra-pool LP competitiveness in AMMs ✨

LPs strive to benchmark their performance accurately. This research enhances the reliability of such calculations.https://t.co/oZ5hDXTh9g

— Uniswap Labs 🦄 (@Uniswap) June 5, 2023

The Blind Spot in Evaluating LP Performance on Uniswap

Since its launch in 2018, Uniswap, as the pioneer of AMM automated market makers, has laid an important foundation for the development of the DeFi industry. Uniswap stated that the protocol has processed a total of $1.5 trillion in trading volume to date. The key to Uniswap's success lies in the fact that "anyone can create a market for any token and provide liquidity without permission, ensuring fair competition among all market participants."

However, the success of AMMs largely depends on liquidity providers (LPs), who provide liquidity for token swaps and earn transaction fees. Uniswap indicates that a financially rational LP will measure returns and costs when providing liquidity, with returns quantified through transaction fees, while costs are more difficult to calculate. Apart from general market risks, LPs also need to consider the information asymmetry with other trading counterparts, as those with more market information may incur losses in trades.

Currently, the LVR loss versus rebalancing metric is often used to measure LP performance, which quantifies the information imbalance between LPs and their counterparts. However, Uniswap believes that LVR does not consider a key factor in AMMs, which is the competitive relationship between different LPs in the same liquidity pool.

Uniswap's New Metric: FLAIR

In a recent study, Uniswap introduced a new metric called FLAIR (Fee Liquidity-Adjusted Instantaneous Returns) to measure the competitiveness of LPs and complement LVR, aiming to understand the dynamic behavior of LPs in liquidity pools.

Uniswap states that FLAIR embodies a rational economic incentive, where LPs allocate capital to pools with higher returns, rebalance liquidity within a range, and adjust liquidity deployment during high-yield periods to enhance competitiveness within the liquidity pool.

In simple terms, LPs that rebalance frequently tend to earn more transaction fees on average, and the FLAIR metric is used to measure this factor.

Using the example in the image below, while LVR would consider both the green and blue liquidity holdings as low-cost, FLAIR can differentiate between them by analyzing the competitiveness of LPs.

With FLAIR, researchers can measure LP positions in any time frame and quantity to assess historical performance, allowing potential LPs to optimize future capital allocations through backtesting or categorize different strategies and LPs based on quadrant charts. Additionally, FLAIR is applicable to most typical AMMs and can be modified for traditional exchanges to facilitate comparative studies across different market structures.

To further understand the FLAIR metric, you can refer to the complete research paper.