Potion Protocol Review: The Next Generation AMM for Risk Management

Potion Labs (now Ntropika Labs)
3 min readApr 7, 2022


Published in Coindoo.com

We know from the popularity of our articles covering cryptocurrency risk management that it’s an issue many of you are concerned about.

In fact, last August Hellen wrote about one key technique: Position Sizing. In her words, ‘you should only ever use an acceptable amount of your money for any given trade’. She gave the example of betting 10% of your pot, so that you avoid losing all of your capital if something goes wrong.

But what if you could know the exact optimal percentage to bet? And what if there was a machine that would place these bets automatically? This is what PotionLabs have created with the Potion Protocol, a new approach to autonomously managing cryptocurrency investment risk based on Automated Market Makers (AMM).

The risk management tool DeFi’s been waiting for

PotionLabs believes that DeFi lacks one of the fundamental pillars of any financial system: risk management. They are fully aware of the limitations in current cryptocurrency trading, most notably, the severe risk in long-term liquidity supply that exposes liquidity providers (LPs) to extreme capital losses.

The Potion Protocol addresses this challenge, whilst also staying true to the ethos of DeFi. Using a unique and compelling NFT launch mechanism, Potion Unlock, they are allowing the protocol to be deployed and managed autonomously by the wider community. This represents an revolutionary, yet fully regulatory compliant paradigm for decentralized software release.

How does it work in practice?

Potion Protocol allows buyers and sellers to come together and trade at mathematically sustainable prices. Imagine that you buy Potion insurance on the price of Ethereum (ETH), locking in a $3000 price. If the price of ETH falls to $2500, you walk away with a $500 payout. On the other hand, if you take the riskier option and sell Potion insurance as an LP, the protocol will provide you with optimal combinations of premium and utilization.

All of this with AMM, smart contacts and a lovely UX. What’s not to like?

In fact, there’s more. Using Potion Analytics, users can create and customize their own Potion insurance recipes based on simulations. This tool provides:

  • Risk optimization: The Potion Protocol uses the Kelly Optimization Criterion to reduce risk and increase the expected return.
  • Sustainable Alpha: Potion Analytics uses a Monte Carlo backtesting system to ensure success rates are higher than those of bankruptcy.
  • Programmable Alpha: Potion analytics offers a backtesting layer to generate return and risk forecasts to help the investor in the long-term.

When will this be available?

This is the REALLY exciting part. The Potion Protocol will be released into the public domain through a novel NFT game, which will require players to work together to unlock an encrypted password. There is loads to love about this approach, and we encourage you to read more. Be quick however — the NFTs you will need to play will go on sale via a Dutch-style auction on March 14th 2022.

Further reading

If you’re interested in the mathematics behind the Potion Protocol, then you’ll want to read their article on the Kelly Machine. That’s because the protocol is based on an adaptation of the Kelly Criterion, a systematic allocation strategy used by some of the best risk practitioners in the world. It provides a mathematical framework to make optimal capital allocation decisions under uncertainty and has been shown to work in practice.

If you’re interested in the design process underpinning the unique NFTs, take a look at their Deep Dive on Design.

If you’re a DeFi enthusiast, you can join the Potion Discord channel where you can access the latest community updates and engage further with the excitement building around Potion Unlock.

Safe to say, PotionLabs are one to watch.

​​Twitter: https://twitter.com/PotionLabs

Linktree: https://Linktr.ee/PotionLabs