« Ownerless Liquidity », « Price floor », « FWV Backed by ETH concept »
Uniswap V2 is a decentralized exchange platform (DEX) enabling users to trade cryptocurrencies without intermediaries. Central to its functionality are liquidity pools, facilitating the exchange between various cryptocurrencies. These pools are composed of reserves of two different tokens, such as FWV and ETH. When a user desires to purchase some FWV, they deposit a certain amount of ETH into the pool and withdraw the corresponding FWV amount. This process is automated, with the price of one FWV unit in relation to ETH determined through an Automated Market Maker (AMM) without the need for order books. The AMM calculates the real-time price of FWV against ETH based on the available quantities of FWV and ETH tokens in the liquidity pool.
The formation of the liquidity pool occurs when a user simultaneously deposits a certain amount of FWV and ETH into the pool. At this moment, they receive liquidity provider tokens (LP tokens), representing their share in the pool. However, in « ownerless liquidity » scenarios, LP tokens are intentionally burned or rendered inaccessible, offering distinct advantages:
- Unruggable Liquidity: Burning LP tokens renders the provided liquidity « unruggable, » meaning it cannot be withdrawn. This boosts confidence in the liquidity pool’s stability.
- FWV Backed by ETH: If liquidity is contributed in FWV and ETH, and LP tokens are burned, it results in FWV effectively being backed by the ETH in the pool. Consequently, ETH guarantees some intrinsic value, setting a price floor for FWV, as there is a finite ETH amount against which FWV can be exchanged.
Understanding the FWV/ETH price floor in Uniswap V2 Pool
Initially, the FWV/ETH pool establishes the FWV’s price against ETH as:
where Xethi is the ETH amount collected during the project’s first phase,
and Xfwvi equals the FWV amount distributed during the same phase.
It’s critical to note that with the liquidity pool created using Xethi and Xfwvi, an equal FWV amount is already circulating, as these FWVs were purchased by users in the project’s first phase. Hence, the total available FWV quantity (wallets + pool) doubles to 2 * Xfwvi.
Uniswap’s AMM relies on a formula central to establishing FWV’s price against ETH:
This means the product of FWV and ETH quantities forming the pool always equals a constant, which is the initial tokens’ product quantity.
Throughout the liquidity pool’s life, FWV’s price in ETH is determined by the token quantities held in the pool:
where Xeth is the current ETH amount in the pool,
and Xfwv equals the current FWV amount. These quantities vary according to user buying and selling activities.
The « price floor » is defined as FWV’s price against ETH when all circulating FWV are sold back to the liquidity pool, effectively doubling the initial FWV quantity in the pool. Given Uniswap’s liquidity pool formulas, we can determine the price floor as:
where Xethf is the final ETH amount in the pool when the price floor is reached,
and Xfwvf equals the final FWV amount.
Since we have :
We deduce :
And we have :
Thus :
Thus :
The chart above represents the change in price of FWV relative to ETH in the dystopian scenario in which all FWV are sold upon initiation of the liquidity pool.
For simplicity and clarity, this explanation intentionally omits the influence of transaction fees and additional liquidity contributions after the pool’s creation.
Conclusion
The « price floor » in a Uniswap V2 pool represents the lowest price a token can achieve, determined by the AMM mechanism and liquidity ratios. Selling all FWV for ETH allows users to reclaim half of the initially deposited ETH, with the « price floor » representing a quarter of the initial price.