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title: 'Hyperdrive Content #2: LP into Hyperdrive'

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# Hyperdrive Content #2: LP into Hyperdrive

The [previous article of our Hyperdrive series](https://hackmd.io/K3WDYQOdRwWRJzVZwFRkNg) defined the Market Sentiment Indicator (MSI) as the price at which yield exposure is traded. It also explored how Hyperdrive's AMM facilitates such trading through long and short positions. This time, we'll learn about another important agent in the Hyperdrive ecosystem: the Liquidity Provider.

### What is Liquidity?
Liquidity measures how easy it is for an asset to be traded into cash without affecting its price. You can usually sell a stock or a crypto token (liquid) much more quickly and easily than you could sell a house or an NFT (illiquid).

Market making or providing liquidity for assets that are frequently traded is profitable both in traditional finance and in DeFi, because liquidity providers get trading fees.

### Market Making or Providing Liquidity

When one user longs, the market maker commits a same-sized short into their inventory. If they're able to find someone else to take this short, they'll make that pair trade and not have to commit any capital. Providing liquidity in DeFi is similar.

However, in traditional finance, banks or agencies who deal in market making for fixed income assets have another layer of liquidity to consider: their own accounting liquidity. They need to have enough liquidity of their own to pay back their users' deposits.

In the event of a bank run, the bank's accounting liquidity may be compromised, forcing them to close the fixed income positions they've commited to inventory, potentially at a loss. They may also find market liquidity constraints, making it difficult to find a counterparty that is willing to buy these positions off of them.

In DeFi, these risks are diminished. There is no central entity that determines where the rates will go, so sudden spikes or drops are up to the market. At the same time, market makers in DeFi can passively keep up with these sudden changes, thanks to AMM mechanics.

### Providing HyperLiquidity

The LP position in Hyperdrive takes it a step further, becoming a powerful new yield primitive. It's only exposed to the base asset and the fixed rate version of that same asset, whose price action follows the MSI. This eliminates the risk of impermanent loss, and means the LP reaps profits from three different sources:
1. **Trading fees:** LPs provide the liquidity against which other users trade. Whenever a trade happens, the user pays trading feesP. This is especially profitable during periods of high yield rate volatility, as users are naturally motivated to open and close positions.
2. **Yield farming with idle capital:** LPs get variable rate exposure because all of the capital that is not tied up in long or short positions from the market is deployed on the yield source.
3. **The crowd's wrong predictions:** When the market's aggregate position is imbalanced, the LP takes the other side of the trade, so if the market incurs a loss, the LP profits.

### The HyperLiquid position

Since the LP position also acts as a counterweight to the market sentiment, it will always automatically rebalance into a long or short position, depending on the market's imbalance. It's a passive yield-seeking investment!

> For every user action, there is an equal and opposite LP reaction.
> 
> -- Some stranger on the internet

When market sentiment is high, it means there are many shorts, so the LP is in a relatively high fixed rate long position.

When market sentiment is low, it means there are many longs, so the LP has a higher variable rate exposure due to its short position.

Furthermore, it's the traders who pay for all this automatic rebalancing, since it's their trading activity (along with their trading fees) that drives these movements.

With this, we can see how Hyperdrive not only brings new functionality for users to trade across yield products, but also provides the foundations for a balanced market where users on both sides (long or short) can coexist without the need for external incentives, while LPs can passively turn a profit in most market conditions.

### HyperLiquidity is Forever

Opening a long is akin to buying fixed rate bonds, which are traded for fixed terms. However, LPs in Hyperdrive don't need to worry about term durations: their liquidity underwrites all user trades for all terms, while the AMM logic ensures that all assets are properly backed.

Thanks to this, It's not necessary for LPs to keep track of term durations and maturity dates. Their liquidity is continuously available for new long and short positions, eliminating the need to roll liquidity over, a common issue in fixed term investments.

Stay tuned for our next article of our Hyperdrive series, where we'll go over some of the overarching market effects that result from trading activity on Hyperdrive, and some of the cool new use cases that Hyperdrive unlocks on DeFi. See you next time!


# ----------------MIHAI NOTES-----------------

could make it a more high level thonk-piece like
"what is liquidity"
"how is liquidity different between tradfi and defi"
"how does hyperdrive improve liquidity in defi"
-> EVERLASTING LIQUIDITY MOTHERFUCKERS
also, no fragmentation between terms
that's actually the magic of hyperdrive
which should probably its own piece on how we do it
but you can introduce the concept like
"you can trade any term at any time, w/ full liquidity"
we need to find a way to sell that concept
cus that's like, the biggest benefit
to hyperdrive
ONE POOL TO RULE THEM ALL
some shit like that

draw analogies to GMX w/ their GLP
maybe sprinkle in some profitability numbers (made up simulated)


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# LP into Hyperdrive
The LP position in Hyperdrive is a powerful new yield primitive. It isn't like other AMM LP positions where the LP can be disproportionally affected by high impermanent loss, because the LP is providing liquidity for like-kind assets. For example, in the case of stETH, the AMM allows for users to trade between fixed rate ETH and ETH, also known as the market sentiment indicator (MSI). As discussed in a previous article, the market sentiment indicator (MSI) represents what the market believes the average yield of a position to equate to.

stETH
3 month: 6%
6 months: 5%
1 year: 3%

As day to day fluctuations happen on the yield of a position, shorts and longs are incentivised to open and close, regulating the market to follow the fluctuating variable yield. Through all of this, the LP takes fees, but also gets exposure to a lot more.

Any capital that isn't allocated to shorts and longs gets exposure to the underlying yield, stETH in this example. On the capital that is allocated to a balance of shorts and longs, the LP position takes the opposite side of the market.

If the SMI thinks the 1 year yield is 3%, but in reality the underlying variable position yield drops drastically to zero, the LP got fixed rate exposure as a hedge. This is great.

If variable rate is actually higher than 3%, the LP gets multiplied variable exposure on the spread or difference.

If the market is 100% right, the LP still gets trading fees and might earn less yield than the original position. But as can be seen from other markets such as GMX, perps, etc.., the crowd rarely is correct. This allows for the LP position to act as a dual sided hedge, garnering extra yield along the way.

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