Cointime

Download App
iOS & Android

What is Impermanent Loss?

Impermanent Loss is the difference in asset value between holding assets in the wallet (HODL) and holding assets in the liquidity pool.

Impermanent Loss is most common in traditional pools where the liquidity provider (LP) must provide both assets in equal proportions and one of the assets is volatile in comparison to the other.

Impermanent Loss is exemplified by Uniswap’s DAI/ETH liquidity pool, where both tokens are represented in a 50:50 ratio:

  1. Stake in a pool of 1 ETH and 1,000 DAI.
  2. After a week, 1 ETH is equal to 2,000 DAI.
  3. If we had stored 1 ETH and 1000 DAI, the profit would be 50% (the value of 1000 DAI would not change, but the price of 1 ETH would increase to 2000 DAI).
  4. Staking tokens in the AMM pool on Uniswap yields less than 50% profit than simply storing assets.

Impermanent or unrealized losses are so named because they are not fixed until the liquidity tokens are withdrawn from the pool. In the preceding example, there are no impermanent losses if the price of ETH returns to the original 1,000 DAI and funds are withdrawn thereafter.

Uniswap, SushiSwap, and other similar AMMs use a simple formula:

x ∗ y = k

x is the number of tokens for asset A;

y is the number of tokens for asset B;

k is the so-called constant product of the pool — this value does not change.

Example of the Uniswap exchange DAI/ETH liquidity pool. Data: The Chain Bulletin.

The contract held tokens with an approximate value of $153.5 million — 29,116.6 WETH and 76.7 million DAI.

Using the formula above, we calculate the value of k for this pool at this time:

29 116,63 ∗ 76 737 921,22 ≈ 2,23 ∗ 10¹²

k changes only when users add or withdraw liquidity, or when transactions are charged a fee (for example, 0.3% in the case of Uniswap). These funds are added to the total liquidity in the pool.

Impermanent Loss in the classic pools

Example of Uniswap exchange DAI/ETH liquidity pool:

  1. When we stack 1 ETH and 100 DAI, the liquidity provider’s share is 10%.
  2. The pool contains 10 ETH and 1000 DAI.
  3. A week later 1 ETH trades for 200 DAI.
  4. There are no commissions in the pool.
  5. We calculate the non-permanent losses.

To determine the exact share in the pool (in each token), you can use Uniswap Analytics and SushiSwap Analytics platforms or third-party tools Croco Finance, Growing and APY.vision

Why should pool commissions be considered?

Commissions are an integral element of the economics of AMM-based platforms.

The higher the commission, the lower the non-permanent loss. When a certain amount of trading fees is reached, participation in the pool generates more profit than holding assets.

Let’s take the preceding example above and add a component in the form of commission:

  1. We steak in a pool of 1 ETH and 100 DAI;
  2. Our steak share is 10% (in a pool of 10 ETH and 1000 DAI);
  3. After a week, 1 ETH trades for 200 DAI;
  4. Commissions: 1 ETH and 100 DAI.

The non-permanent loss, excluding trading commissions, is 17.179 DAI. Because we have a 10% stake in the pool, we are entitled to 0.1 ETH and 10 DAI of the accumulated commissions. Given that ETH is currently trading at 200 DAI, 0.1 ETH is worth 20 DAI, and the total profit from commissions is 30 DAI. The total is thus $312,821 ($282,821 + $30).

Insert these new numbers into the formula — stackingUSD/storageUSD — 1:

312,821/300–1 ≈ 0,042 ≈ 4,2%

In this example, the non-permanent loss is -12,821 DAI (17,179–30). This is not a loss but a 4.2% gain because assets are held in the pool rather than held individually.

Does Impermanent Loss work in other pools?

Curve is a decentralized stabelcoin and tokenized bitcoin exchange based on an automated market maker mechanism. Its pools contain only assets that must have the same or comparable value: stabelcoins (USDC, DAI) or tokenized bitcoins (renBTC, wBTC). The risk of volatile losses in such pools is minimal.

Balancer provides token pools with arbitrary token ratios. For example, if a liquidity provider wants to supply a large number of specific tokens, it can select a pool in which those coins are weighted more heavily than others (the proportions can be 80/20 or even 98/2). In addition, this model minimizes non-permanent loss. The greater a token’s share of a pool, the smaller the difference in outcomes between holding a token and providing liquidity in that token.

Bancor version 2 pools automatically adjust token weights based on price oracle data. This allows you to reduce volatile losses even in pools containing volatile assets.

How to calculate Impermanent Loss easily?

Understanding Impermanent Loss is necessary for any user of AMM platforms. You can make your own IL calculations using the calculator at dailydefi.org (based on Uniswap formulas).

In general, regardless of price movements, AMM protocol users are always exposed to the risk of foregone costs. In comparison to custody, when asset prices rise, a participant’s position grows less; when prices fall, they lose more.

Trading commissions and income farming come to the rescue, helping to neutralize volatile losses so that participation in the AMM pool yields more profit than simply holding assets.

Get the latest news here: Cointime channel — https://t.me/cointime_en

Comments

All Comments

Recommended for you

  • Forbes survey: More than a third of Wall Street leaders oppose Trump's economic policies

    Forbes recently conducted an investigation into President Trump's economic policies, contacting 50 of the most influential figures on Wall Street, including billionaire investors, heads of large institutional asset management companies, and top financial advisors in the United States, to understand their views on Trump's economic strategy since taking office.

  • AI infrastructure platform Mahojin completes $5 million financing

    AI infrastructure platform Mahojin has completed a $5 million financing round, led by a16z CSX and Maelstrom. Mahojin aims to create a "GitHub" for AI model creators and dataset developers, with the platform enabling intellectual property tracking and rewarding the original contributors of models and datasets.

  • A senior Brazilian official: Bitcoin reserves are "crucial" to Brazil's prosperity

    according to Decrypt, Pedro Giocondo Guerra, senior advisor to the Vice President of Brazil, stated in a recent speech on behalf of the government: "The strategic reserve of Bitcoin is crucial for the prosperity of the country. Discussions about establishing a BTC reserve may be a key factor in deciding the prosperity of Brazil, in line with the interests of the country and the public." Brazilian congressman Eros Biondini (PL-MG) previously proposed legislation to establish a "strategic sovereign Bitcoin reserve" (RESBit). Holding 5% of foreign exchange reserves (international reserves) in Bitcoin, the Central Bank of Brazil will use advanced monitoring systems, blockchain technology, and artificial intelligence to monitor transactions and be responsible for custody.

  • Bitpanda receives broker-dealer license from Dubai Virtual Assets Authority

    Bitpanda, headquartered in Vienna, has obtained a broker-dealer license from the Dubai Virtual Asset Regulatory Authority (VARA).

  • US artificial intelligence startup Yutori raises $15 million

    Yutori, a startup based in San Francisco, has raised $15 million for the development of an artificial intelligence personal assistant.

  • Meme incubation platform Coresky completes $15 million Series A financing

    Meme incubation platform Coresky announced the completion of a $15 million Series A financing round, led by Tido Capital, with WAGMi Ventures, Copilot Venture Studio, Web3 Vision Fund, and Parallel Ventures participating. The valuation information has not been disclosed, and the company's total financing to date has reached $21 million.

  • Vest Labs Completes $5 Million Seed Round of Financing, with Amber Group, QCP Capital and Other Investors

    Vest Labs, a financial infrastructure company based on real-time risk pricing, has announced the completion of a $5 million seed round financing, with participation from Jane Street, Amber Group, Selini Capital, QCP Capital, and Big Brain Holdings. The new funds will be used to support its construction of a real-time, verifiable risk pricing model based on zero-knowledge proofs to enhance financial market transparency and efficiency, and will also launch a perpetual futures trading platform supporting Arbitrum, Solana, Base, and other L2 solutions.

  • Digital asset high-frequency trading company ABEX completes new round of financing of US$6 million

    ABEX, a digital asset high-frequency trading company based in London, United Kingdom, announced the completion of a $6 million financing round, led by MMC Ventures. The new funds are intended to be used for the launch of derivative trading and algorithmic execution solutions to improve the transaction execution efficiency of centralized and decentralized financial venues. It is reported that the company is registered with the Financial Conduct Authority (FCA) in the United Kingdom, allowing it to engage in cryptocurrency trading activities.

  • Coindesk ·

    Careers in Crypto: 5 Insights for 2024

    In an overwhelming job market, leaning into personal networks and connections are more important than ever. Emily Landon, CEO of The Crypto Recruiters, outlines what is happening in the crypto job market and how you can position yourself or your company in 2024.

  • Coindesk ·

    Crypto Needs to Radically Rethink Token Distribution

    The prevailing “low float, high FDV” model can generate significant initial interest in project but benefits tend to disintegrate in the long-term, says Lava Network's Ethan Luc.