CHAPTER 06 / 8 · Evaluate the strategy
Understand the other side of your fees.
Connect quote quality and policy checks with sustainable trading activity.
Liquidity earns swap fees only when people use it. A trader compares the amount received, execution conditions and costs. Serving traders well is part of building a useful market for LPs.
Jump to the interactive experiment ↓A profitable arbitrage can be costly inventory turnover for LPs
Imagine the external ETH price jumps before the pool has traded. An arbitrageur buys ETH while moving the pool upward; the average pool execution can be below the new external price. LPs earn fees, but sell inventory for less than a hypothetical immediately updated market quote. That gap is why “more arbitrage volume” is not automatically “better LP returns.”
Arbitrage also keeps markets economically connected. The useful question is whether fees and the desired inventory outcome compensate for the execution disadvantage and costs. A stale price, a good fee and a high-volume chart cannot be evaluated independently.
GO DEEPERDistinguish fee income from trading edge.
Marginal price is not average execution
In a fee-free full-range pool starting at x = 100 ETH and y = 270,000 USDC, spot is y/x = 2,700. A trader buying 10 ETH leaves 90 ETH, so the new USDC reserve is 27,000,000/90 = 300,000. The trader pays 30,000: average execution 3,000, ending marginal price 3,333.33. Selling 10 ETH instead pays out 24,545.45 USDC, averaging 2,454.55, ending at 2,231.40. These are separate trades from the same start. Price impact is curve movement; slippage tolerance is a transaction constraint, not a fee.
The benchmark behind LVR
Loss-versus-rebalancing compares AMM principal with a hypothetical self-financing portfolio that follows its inventory but trades at external market prices. It isolates an adverse-selection cost under its modeling assumptions. It is not the initial-token holding benchmark used by IL. The research model assumes idealized trading and arbitrage; an actual hedge pays costs and cannot trade continuously. Use the distinction as an analytical lens, not a promise of achievable benchmark returns.
Same ending price, different path cost
For a discrete toy comparison, let xᵢ be LP ETH inventory at Pᵢ. A comparator starting with the same capital first earns xᵢ₋₁(Pᵢ−Pᵢ₋₁), then rebalances at Pᵢ without fees. Its final value minus LP principal is the illustrated rebalancing gap. A round trip can return the LP to its initial inventory, giving zero endpoint IL, while the comparator ends ahead. This discrete calculation is not an estimator from live swap logs, and finite step sizes matter.
Local curvature explains the direction
For a small step away from boundaries, xδP − δV ≈ −½Γ(δP)², which is nonnegative for a standard LP. The continuous, frictionless analogue integrates curvature against price quadratic variation. This connects short-convexity exposure to path cost; it does not say realized fee income is fixed. Fees, inventory returns, execution quality, capital costs and any hedges must all be evaluated on a consistent basis.
Do not subtract IL and LVR twice
If you already value every asset and reconcile contributions, withdrawals and fees, trading losses are already embedded in actual P&L. IL and LVR are alternative decompositions against different benchmarks, not extra cash expenses to subtract again. For ADPP research, test whether a fee or bound change improves net results and execution quality out of sample. Raising fees may reduce demand; a boundary may reject trades but leave inventory exposed. Policy protection at the Router concerns consistency between quote and execution, not elimination of LP adverse selection.
Depth, price impact and slippage
Price impact is the movement caused by the trade against liquidity. Slippage tolerance limits acceptable deterioration relative to a quote; it does not create deeper liquidity. A large request may fail where a small one works because it crosses a policy bound, exhausts an available range or hits another execution condition. Diagnose the actual error rather than assuming size is the only cause.
Price impact and stale execution are different problems
A 10 ETH buy can have an average price above starting spot even if the external market never moves: it consumes depth. A previously good quote can then worsen before inclusion because other swaps move the pool. Separately, a manager can change the checked fee or bounds.
Trade-size checks, minimum output, deadlines and Router policy binding address different parts of that chain. Policy binding checks the quoted policy fields at execution; it does not reserve liquidity or promise the best price across every venue. A rejected transaction must be diagnosed and requoted, not blindly retried.
What the Market Router binds
AMM Markets Router binds the supported pool-policy fields in a quote to execution checks. If those checked values differ at execution, the transaction reverts. The policy itself is not frozen: other swaps and policy updates may still happen. Matching values do not guarantee an unchanged market price, inclusion or success; other transaction constraints still apply.
TRY IT YOURSELF
Make the mechanics visible.
Change the policy status in the example below. Follow quote → checks → execution outcome. This diagram never requests a real quote or submits a transaction.
Quote
Bind supported policy values
Check
Same checked values
Continue checks
Other constraints still apply
Illustration only. A matching policy does not guarantee execution. A mined revert can cost gas; an off-chain failed quote is not a submitted transaction.
Reach and quality both matter
The Router provides a reference path for traders and integrations. Distribution alone does not guarantee volume, and more volume does not automatically mean better LP P&L: adverse selection and inventory changes matter. A reverted on-chain transaction can still cost gas. A failed quote should be refreshed and understood before any execution attempt.
CHECK YOUR UNDERSTANDING
What does this mean for you?
Would your proposed LP fee and range still offer an attractive quote to the traders you want to serve?
CONNECT IT TO AMM MARKETS
From understanding to a real decision.
Explore a wallet-free reference quote on our separate Router site, then compare it with Markets depth. Developers can inspect the integration guide. Connecting a wallet and executing is a separate, real-money step.
Explore Router quotes ↗Opens a live service. Exploring is separate from submitting a transaction.References and scope
Course edition: October 2026. Distinguish protocol principles from product instructions; actual market parameters come from the live interface and on-chain state.