Introduction

Abstract

The Likwid Protocol marks an important step towards a fully decentralized derivatives protocol in the field of decentralized finance (DeFi). Most existing derivatives solutions rely on centralized platforms or oracles, introducing counterparty risks and potential market manipulation. Likwid Protocol, through liquidity pools based on Uniswap V4, provides a fully decentralized derivatives mechanism that requires neither counterparties nor oracles, greatly enhancing user flexibility in risk management and asset allocation. Likwid Protocol uses a pooled funds model, meaning that the liquidity provided by users is consolidated into a shared pool, and other users can borrow these funds for short-selling or leveraged trading. With this pooled mechanism, loans do not need to be matched individually between borrowers and lenders but instead rely on the total liquidity in the pool and users' collateral. This model allows for instant loan operations based on the pool’s status, maximizing capital efficiency.

The Likwid protocol is designed to facilitate complex derivatives operations, including buying, selling, and shorting of a third-party ERC-20 token Y, with the base token X as the counter asset. Built on Uniswap V4, Likwid maximizes flexibility, capital efficiency, and operational transparency. This integration harnesses Uniswap V4's innovative design features—such, such as modular hooks, singleton pool management, and dynamic fee structures—to support a sophisticated DeFi ecosystem, enabling custom swap logic, adaptive fee algorithms, and flexible accounting practices.

Protocol Overview

The following diagram illustrates the overall architecture of the Likwid Protocol.

In the diagram:

• Depositors: Provide funds to the pool for borrowing and earn interest in return.

• Derivatives Traders/Borrowers: Borrow tokens from the liquidity pool for leveraged trading or short-selling operations.

Role of Liquidity Providers

In the Likwid Protocol, liquidity providers play a crucial role. They contribute funds by depositing cryptocurrency assets into the liquidity pool. These funds can then be borrowed by other users, and liquidity providers earn interest in return. Likwid's design ensures that interest rates are adjusted algorithmically to reflect the pool's utilization and market conditions. Specifically:

• Dynamic Rate Adjustment: The interest rate earned by liquidity providers depends on the amount of available funds in the pool. As funds are borrowed, the available liquidity in the pool decreases, causing interest rates to rise to incentivize more users to provide liquidity.

• Fee Rewards: In addition to interest income, the protocol distributes a portion of the fees generated from derivatives transactions as rewards to liquidity providers.

• Stable Fund Management: The funds in the liquidity pool are used to support derivatives traders' operations. Likwid Protocol manages different sources of funds and liquidity pool characteristics to ensure that liquidity providers can withdraw their funds at any time. The algorithm retains a certain proportion of liquidity reserves to ensure sufficient liquidity is available when users need to withdraw their assets.

This mechanism not only improves capital efficiency but also provides a more stable source of income for liquidity providers.

Role of Derivatives Traders

The Likwid Protocol offers a unique solution for Derivatives Traders that eliminates the need for counterparties, allowing users to borrow target tokens by collateralizing assets and engaging in derivatives operations. This mechanism is distinct from traditional financial market derivatives methods and offers several advantages:

• No Counterparty Matching: Likwid provides funding for derivatives traders through a liquidity pool, allowing users to directly borrow tokens from the pool without needing to wait for a counterparty. This approach significantly enhances trading efficiency and flexibility.

• No Oracle Dependence: Likwid adopts a design without reliance on oracles, thereby avoiding the risks of market manipulation and price tampering. The funds borrowed by derivatives traders and the trading price are derived directly from the state of the liquidity pool, removing the dependency on external price feeds.

• Leverage Trading Support: derivatives traders can obtain leverage by collateralizing base tokens, enabling users to control larger market positions with less capital, thus amplifying potential returns. The protocol's collateral rate and leverage design ensure that users can effectively manage risk while benefiting from leverage.

This counterparty-free and oracle-independent derivatives mechanism provides users with a novel decentralized risk management tool, allowing them to predict and act on market movements without intermediaries. The innovation of the Likwid Protocol lies in its use of Hooks to implement customized trading logic and its reliance on Uniswap V4's liquidity pool design, ensuring that derivatives operations are entirely decentralized. Additionally, Likwid offers a flexible interest rate mechanism that dynamically balances returns and risks between derivatives traders and liquidity providers.