Liquidity provisioning

Similar to how AMMs need liquidity to facilitate trades, notional's liquidity pool for fCash and Cash also needs liquidity to function.

As we already covered that lending and borrowing rates are computed based on the exchange rates and the time to maturity. Having lower slippages in the borrowing and lending trades would keep the rates less volatile and benefit Borrowers and Lenders to get better rates.

Low slippage can occur when there is high liquidity in the liquidity pool or if the liquidity is concentrated in a tight range. Notional's fCash markets (AMM) use both. Notional provides incentives for LP so the liquidity naturally grows and also concentrated liquidity in such a way that the liquidity pool is used efficiently without creating a downside for the LPs.

Liquidity providers contribute Cash and fCash to the liquidity pools of their desired maturity date and act as counterparties to the lenders and borrowers that are active on the protocol. In exchange for their contribution, liquidity providers earn fees every time a lender or borrower trades between currency and fCash.

In v1 LPs can choose whatever maturity liquidity pool they wish for (3 Months, 6 Months, 1 Year). This was enhanced in v2 where liquidity allocation was automated for the LPs. LPs contribution of Cash and fCash is done with respect to the current Cash and fCash proportion in the liquidity pool.

Liquidity Tokens

Liquidity tokens are a coupon that represents a share in the liquidity pool i.e. fCash + Cash in the ratio of the current balance between fCash & Cash in the liquidity pool. Liquidity tokens represent their proportional claim on the currency and fCash tokens in that pool. A liquidity provider can redeem liquidity tokens for these underlying assets at any time.

Supplying Liquidity

To deposit currency into a liquidity pool, a liquidity provider first specifies a liquidity pool (Maturity) and the amount of cash they want to supply as liquidity. Then the liquidity provider mints a pair of fCash tokens. Again the amount of fCash minted is based on the pool proportion.

For example, if you were to provide 100 DAI as liquidity in a liquidity pool having the current proportion of Cash:fCash as 51:49, you would mint 96.078 +ve fCash and 96.078 -ve fCash.

Cash to be supplied as liquidity = 100 DAI Current fCash proportion = 49% i.e. 0.49 fCash pair mint = 100 * 49% / (1-49%) = 100 * 0.49 / 0.51 = 96.078

Note that it is only possible to provide liquidity with the current pool proportion and with no other desired proportion. The reason behind this specific mechanic is to protect LPs from getting into a net Borrowing or Lending position with the same trade of providing liquidity.

The liquidity provider then deposits their Cash and the positive fCash into the liquidity pool and receives liquidity tokens in return.

Now the liquidity provider has liquidity tokens and an obligation that is offset by the positive fCash that their liquidity tokens entitle them to.

At a ratio similar to the time when a user provided the liquidity (0.49 in our example), liquidity tokens represent the claim on 100 DAI and 96.078 +ve fCash. But if the pool proportion changes from the initial, the liquidity token claims would also change. This change in liquidity token claims would create a net fCash position for the liquidity provider.

This would be explained in detail in the next section.