1️⃣Introduction

In a decentralized exchange (DEX) such as Uniswap V2, liquidity providers deposit assets into liquidity pools to facilitate trades through automated market makers (AMMs) and receive liquidity pool tokens (LP tokens) in return. The purpose of these LP tokens is to allow liquidity providers to claim the fees collected in addition to the initial stake.

Nevertheless, risks arise with LP tokens from fluctuations in the market value of the underlying assets. Indeed, the impermanent loss represents the losses that occur when the current price of an asset differs from the initial price when adding liquidity. Furthermore, the main risk incurred by traders is the slippage. For a given order, the slippage corresponds to the difference between the expected price and the price at which the order is executed.

Therefore, a LP token is considered to be of good quality if impermanent loss and slippage are low. Then, the rating methodology defines the market risk measure (MRM) and the liquidity risk measure (LRM) in order to quantify these risks.