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Delta-Neutral Liquidity Provision: Structuring AMM Yield Without Market Exposure

  • May 15
  • 3 min read

Updated: May 16

Providing liquidity in DeFi automated market makers (AMMs) has long been marketed as a high-yield opportunity. But for allocators managing meaningful capital, unhedged LP exposure comes with structural risks: impermanent loss, correlation decay, and inconsistent performance.


At AXM Capital, we view liquidity provision not as a passive yield product, but as a capital structure problem. This post outlines how we build delta-neutral liquidity strategies that extract real yield from AMMs, without exposing capital to price movements or speculative volatility.



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What Is Delta-Neutral Liquidity Provision?


Delta-neutral liquidity provision refers to providing capital to AMMs in a way that earns trading fees and incentives while offsetting the directional (price) risk of the underlying assets.


For example, instead of holding an ETH/USDC LP position and being fully exposed to ETH price swings, we structure a hedge, through on-chain derivatives or synthetic positions, that neutralises the net directional exposure.


This allows us to target fee capture and protocol incentives while minimising drawdown due to asset price volatility.



Why Traditional LPing in DeFi Is Structurally Risky


Unhedged LP positions introduce several challenges that are often misunderstood or ignored:


  • Impermanent Loss: When assets in the pool diverge in price, LPs lose value compared to holding the assets directly.

  • Volatility Drag: High volatility in either asset can erode returns, even if volume is high.

  • Correlation Decay: Even seemingly stable pairs (e.g., ETH/stETH) can diverge in short-term movements.

  • Exit Risk: Low liquidity or sudden TVL changes can trap capital or force exits at poor execution levels.


For institutional capital or discretionary mandates, these risks often outweigh the advertised APY.



How We Structure Delta-Neutral LP Strategies


Our approach transforms AMM exposure from a speculative bet into a governed strategy with embedded execution controls.


1. Vault-Based Architecture

Each strategy is deployed through a dedicated smart contract vault. These are non-custodial, isolated, and designed with encoded risk logic, ensuring capital moves only within predefined tolerances.


2. Paired Position Design

We select pools with strong fee potential and hedge the primary directional exposure. This can be done through:


  • On-chain perpetuals (e.g., short ETH to hedge ETH/USDC LP)

  • Synthetic token pairs

  • Cross-pool correlation overlays


This pairing design maintains exposure to fee volume, not market direction.


3. Execution Parameters

Each vault encodes parameters such as:


  • Slippage thresholds – to prevent entry into shallow or volatile markets

  • Volatility bands – to reduce deployment during unstable periods

  • Liquidity floors – to ensure depth is sufficient for rebalancing

  • Circuit-breaker logic – to automatically pause redeployment if risk thresholds are exceeded


These parameters are enforced on-chain, removing execution discretion and increasing allocator confidence.




Yield Drivers: Where Performance Comes From


We focus on real yield, not transient token-based incentives. Key return sources include:


  • AMM Trading Fees: Derived from actual swap volume in the selected pool.

  • Incentive Programs: Where applicable, tokens are claimed and converted to base assets.

  • Structural Arbitrage (if present): Some positions benefit from cross-pool or cross-chain liquidity inefficiencies.


We never rely on emissions farming or unsustainable APYs.




Example Scenario: Hedging an ETH/USDC LP


Let’s walk through a simplified structure:


  • Strategy enters an ETH/USDC LP pool on Uniswap v3.

  • Simultaneously, the vault opens a short ETH position on a decentralised perpetual protocol.

  • Exposure is balanced to net delta ≈ 0.

  • Slippage, volatility, and depth logic restrict rebalancing events to predefined conditions.

  • Result: The strategy earns LP fees from ETH-USDC volume while neutralising directional exposure.


This model can be adjusted to target different pools, hedge ratios, and duration preferences, depending on the mandate.




Why This Matters for Capital Deployment


Delta-neutral liquidity provision offers allocators a way to access DeFi-native yield without making price bets. For high-net-worth individuals, family offices, and fund managers, this structure:


  • Reduces drawdown potential from volatility

  • Provides clarity on risk exposure

  • Aligns with longer-term, scalable capital deployment


It moves LPing from speculative to structural.




Further Information


We share internal memos covering vault logic, risk modeling, and execution architecture for allocators evaluating structured AMM exposure.




 
 
 
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