Pool Attractiveness Evaluation – Introduction

According to a study by Topaz Blue and Bancor, 49.5% of Uniswap V3 liquidity providers lost money due to impermanent loss. Yet recent research shows a small fraction of LPs still achieve triple-digit APYs. The difference? A systematic approach to evaluating opportunities.

This is the first article in a series on AMM DEXs Liquidity Provision, designed to bootstrap onboarding for new participants, hopefully provide value for established players, and give insight into how we operate in this space.

First, I think it's worth settling on the motivation of what we call a Liquidity Provider. For this article, we'll narrow it down to:

"Make a profit from investment by providing liquidity that's measured in fiat or other stablecoins, which can be realized and settled at any moment in time"

This is one of many motivations someone could have with Liquidity Provision. However, it's also the most common one, with the next most common differing only in how it measures performance—using coins that aren't tied to any fiat, such as ETH or BTC.

For me, the How To DeFi book series from Coingecko was a great introduction to the space. But you soon realize that to find your spot, you need to find your niche, or "superpower."

At the beginning of my journey, it was about finding the right instrument or protocol that I considered to provide the best ratio of Yield/Sustainability/Risk. This is what I consider at the screening phase, before even starting to research the pool and its attractiveness.

The good thing about all these factors is that they can be easily quantified and applied. Basically, any modern screening tool should be capable of handling such filters without breaking a sweat.

Let's break them down.

Yield

The one always in the spotlight. You always see metrics such as "APRs" and "APYs," but understanding the abbreviation isn't always sufficient to determine whether yield is really that attractive.

The first thing you'd like to look at is what contributes to it. For example, at Pancake Swap (an Automated Market Maker DEX), you can have a position that earns fees from every swap while staying in range, but also earns so-called "Boosted" Rewards for being staked.

Real Example: A ETH/USDC pool showing 150% APR might break down as:

• Trading fees: 20% APR (sustainable)
• Boosted rewards: 30% APR (often temporary, paid in DEX tokens)
• Underlying upside: 100% APR (can reverse at any time)

You might notice that in this case there are 3 external factors that contribute to the APR:

1. Position Range. Since your position earns fees only while staying in range, you need to bet on it. A tighter range (e.g., $1,500-$1,600 for ETH) earns more fees but requires more management than a wider range ($1,000-$2,000).
2. Boosted Rewards. These are usually issued in the DEX's token, the price of which will heavily depend on the tokenomics and the team. It's also important to note that the incentive model, rewards amount, and program duration may change at any given moment.
3. Price of the tokens. While you are always earning fees and can't earn negative fees, your position carries exposure to the tokens it consists of. A $10,000 position split 50/50 between ETH and USDC will gain/lose value as ETH price moves, separate from any fees earned.

Sustainability

If the pool is attractive now, it doesn't mean it will stay this way—not even for days, but for minutes. To evaluate this, you need to answer the following questions:

1. What contributes the most to the APR?
   1. Fees – If this is a high volume / low TVL pool, you risk having other players enter the market and dilute your share
   2. "Boosted" Rewards – Can vanish overnight when programs end or token prices crash
   3. Divergence Loss – What many call "impermanent loss"—the opportunity cost of providing liquidity vs. simply holding the tokens
   4. Operational Costs – Gas fees can eat 1-100% of a small position's value just to enter and exit

Risk

With the dynamic DeFi landscape, you always carry risks of immature technology, with a spectrum of risks across all dimensions, including:

1. Underlying Volatility – Meme coins can lose 90% in hours; even "stable" pairs like ETH/BTC can diverge 20%+ in days
2. Smart Contract Risk – Token contracts may have admin functions for minting, pausing, or adding transfer fees
3. Chain Infrastructure – Congestion can spike gas to $500+ per transaction; some chains experience regular downtime
4. Protocol Security – Even audited protocols can have exploits; newer forks carry higher risk

Example of Evaluation Framework

Yield Score:

• Base APR >30%
• Daily volume to TVL ratio >1.0
• Additional yield sources present (boosted rewards, governance tokens)

Sustainability Score:

• Volume/TVL variance <25% (current vs 30-day average)
• TVL growth >0% over past 30 days
• Reward program duration >3 months remaining

Risk Score:

• Underlying token 30-day volatility <50%
• Blue-chip tokens (top 50 by market cap)
• Protocol has 2+ security audits
• Chain uptime >99.5% past 90 days

Next Steps

This was a short introduction to the moving forces in screening opportunities at AMM DEXs, with the aim of giving context to how we operate at xyk.markets.

In Part 2: We'll dive deeper into pool screening techniques, backtesting, evaluation for cost of entry/operations and review case studies of how this is being applied in our operations.

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