NIL Contracts are a new crypto derivative and DeFi primitive with a payout function that perfectly replicates the impermanent loss value (ILV) incurred on a given AMM LP position. Participants can use NIL contracts to go long/short impermanent loss in order to generate returns or hedge their LP positions.
Each NIL contract specifies:
The “main token” that is usually more volatile in the pair
The “base token” which Token A is priced by, e.g. USDC or WETH
The AMM curve that token pair lives on
Token A Strike Price
The price of Token A (expressed in terms of Token B) which is used as the starting price for the impermanent loss value calculation
Strike Price - Token A
A single NIL contract reflects the current ILV of an LP position starting from the token A strike price. After a Buyer opens a NIL contract, the ILV amount will be marked-to-market as the price of tokens fluctuate. When Buyers close a NIL contract, they can claim the mark-to-market ILV amount, thereby hedging the impermanent loss they experienced from their matching LP position.
Strike Price - Token A
Current Price - Token A
Owning NIL contracts with a strike price equal to the price of Token A when you entered the liquidity pool will perfectly hedge out all of the impermanent loss from a LP position, because ILV will mirror any changes in impermanent loss on the LP position as the current price of Token A moves against the strike price.
For pairs with a stablecoin as the base token, a single NIL contract reflects the current ILV of an LP position that had an initial total value of 1,000 stablecoins at the token A strike price.
If you deposited $10,000 into the WETH-USDC pool on Uniswap V2 when WETH = 1,000 USDC
- Your total LP position is worth 10,000 USDC (the base token in the pair)
- Buying 10 UNIV2-WETH-USDC-1000 NIL contracts would completely hedge out impermanent loss on your LP position
- When you exit the liquidity pool, you would close your NIL contracts, and the ILV claimable amount (in USDC) will be exactly equal to the value of impermanent loss you experienced in USDC
For pairs with WETH as the base token, a single NIL contract reflects the current ILV of an LP position that had an initial total value of 1 WETH at the token A strike price.
If you deposited $15,000 into the AAVE-WETH pool on Sushiswap when AAVE = $100 and WETH = $1,000 (i.e. AAVE = 0.1 WETH)
- Your total LP position is worth 15 WETH (the base token in the pair)
- Buying 15 SUSHI-AAVE-WETH-0.1 NIL contracts would completely hedge out impermanent loss on your LP position
- When you exit the liquidity pool, you would close your NIL contracts, and the ILV claimable amount (in WETH) will be exactly equal to the value of impermanent loss you experienced in WETH
In summary, a NIL contract is a crypto derivative product and new DeFi primitive that enables AMM liquidity providers to perfectly hedge impermanent loss risk, by offering a payout structure that perfectly replicates the impermanent loss value on their LP position.