In every guide or resource I’ve read about liquidity pools (LP), a big warning given to all us noobies is to watch out for impermanent loss (IL). I won’t bother going into the definitions but you can do some reading on LPs and IL
While yes, in the world of Crypto coins are shooting to new heights all the time, I feel that worries over impermanent loss is a bit overblown. Given the high APRs and APYs provided when you lend to LPs, most of the risk of IL is mitigated. Let’s take a look at an example using this impermanent loss calculator:
Let’s say you are staking liquidity in a lower risk randocoin-stablecoin pair
Coin A starts at: $10 and of course coin B is at: $1. Eventually Coin A reaches $50 while Coin B stayed at $1. Plugging these values into the calculator gives us an impermanent loss: 25.46%. While you may be thinking OMG I LOST 25.46% OF MY INVESTMENT, it took Coin A increasing by a whopping 500% before you suffer a loss of 25.46% when you sell your investment. OFC in the crazy world of crypto a 500% gain is just child’s play as well, but when we know the risks we can make more informed decisions.
Another thing to note is that if both coins rise by roughly the same %, the impermanent loss suffered is extremely minimal, so if you stake your liquidity in two coins you expect to grow at the same rate, again, impermanent loss should not be a huge worry.
Hopefully this knowledge has helped to remove a bit of fear when it comes impermanent loss and helps some of you develop strategies going forward! As with all investing, LP staking has it’s inherent risks and isn’t just free passive income. So please DYOR 🙂
Talking about IL when a coin goes up is fine, but if you do the math of IL when a coin drops in value, then you’ll see how scary IL really is
Quick question. If the LP isn’t used during the event of Coin A/B rising, would the impermanent loss apply?
From my understanding, the AMM would have to initiate a transfer between the two assets provided or else the original coin+coin values haven’t changed.
In theory you’re right but cryptocurrency ecosystems often have liquidity/aggregation optimizers like 1inch, shared liquidity pools, and a fuck ton of arbitrage bots that are constantly re balancing pools.
Arbitrage traders would be happy to jump in and get a discount on tokens in a LP that doesn’t follow the market price. They drain the token they can sell for more elsewhere and the LP price of both tokens adjusts.
This is theoretically correct. AMM’s dont ‘know’ what token prices are doing elsewhere. If the price they are displaying is wrong, then people will do arbitrage, and it will go back in sync with other exchanges.
So if nobody is making any swaps on that specific pool where you are LPing, then external price movement won’t matter.
You didnt bother going into definitions EITHER tho lol.
You gave one example and didn’t explain why.
? Lol
What if the pair is two stable coins?
practically 0% impermanent loss which is why these pairs are usually the lowest APR
the problem is, you choose an example that serves your purpose. talk about a pair with no stablecoin and IL fears are not overblown… specially with crypto that shoots up
Although in theory you have a well-written, valid point; in practice this can go very badly wrong depending on timing and price movements; I know, because it’s happened to me and I effectively ‘lost’ a good chunk of a stack because the price surged and never came down again (damn you LINK, I love you and hate you for doing that!)
Also many investors don’t consider gas costs for interacting with a smart contract in the first place – depending on what service/network you are using (ERC-20/Ethereum I’m looking at you!!) – the gas fees alone can mean that you have to be investing some pretty big numbers to make it work.
Just be VERY cautious – there’s certainly gains to be had, but LP is far more risky than people realise – they see big APY and get excited, but understand that big price movements and bad timing will wipe out gains quickly, and you can walk away with a far smaller stack than you put in compared to just HODL strategy.
Well, You have a point but if a coin is dropping in value You are fucked. It’s not guaranteed that ones goes up while another stays at the same price which is your worst calculation model in the post.
Hmm, you wrote meaningful information, whole sentences and was not toxic or shouty about it.
That’s not how we do this around here , you are confusing people.
This isn’t going to stop me from commenting ‘Impermanent loss, anyone?’ on any post that has to do with liquidity pairs.
Another thing that can be added onto is that you’ll still be getting rewarded so that 25% loss will be even smaller since you will get some coins in return for providing liquidity.
In fact I feel it’ll be actually better for you if you have tendencies to sell too early as it’ll make it a little more time consuming to well your stake and allow you to hold for longer. This alone might be profitable for you over the longer term even if you take a hit with impermanent loss.
Oops I definitely wanted to mention that somewhere as well!
But you have to remember that most farm tokens will dump hard when the market dumps. So if the markets swings down while you still got farm tokens to harvest or have them staked, you will get spitroasted by impermanent loss and your farm tokens going to shit at the same time
There’s also a lot of dual yield LP’s out there that reward in one of the 2 LP tokens on top of the exchange token (see raydium, trader joe, quickswap, osmosis) further mitigating the risk.
There is nuance to this discussion.
Iet’s say there are two coins you are heavily invested in and truly believe in each coin has a bright future. Then yes, you can LP with some of these coins and the impermanent loss is not so bad because you don’t mind getting stuck with a lopsided amount of either coin and therefore farm them much longer.
However, if you are just chasing juicy APR’s farming shitcoin LP’s, then yes impermanent loss can fuck you up pretty quick if either coin moves fast in any direction
You know the thing about impermanent loss is that, if you are investing in coins you don’t believe in, then when you impermanently ‘lose’ you feel doubly stupid (for both ‘losing’ and expecting a shitcoin to grow).
At least if you invest in coins you believe in, you only feel stupid once.
Similar to buying at the market tanks, selling and the market rises, trying any DeFi will surely create massive impermanent loss. Bad luck has a way of finding us. I’ll stick to DCA, HODL, and Stake lol
It’s not going to be worth it, on its own (might as well hold and do nothing). The only thing that is making it worth it is liquidity mining.
If this is the case it is not really a sign of a healthy economy. I mean if we want to shove to the man, then we should produce a product that actually works and benefit everyone. What good it is if we create an expensive product (it’s not cheap+|slippage) and only makes its backer “lose” money. It is alomst like a lose-lose scenario. It’s like the only thing that makes this works is because of the money printer (someone giving out the liquidity reward that is produced out of thin air).
Talking about IL when a coin goes up is fine, but if you do the math of IL when a coin drops in value, then you’ll see how scary IL really is
Quick question. If the LP isn’t used during the event of Coin A/B rising, would the impermanent loss apply?
From my understanding, the AMM would have to initiate a transfer between the two assets provided or else the original coin+coin values haven’t changed.
In theory you’re right but cryptocurrency ecosystems often have liquidity/aggregation optimizers like 1inch, shared liquidity pools, and a fuck ton of arbitrage bots that are constantly re balancing pools.
Arbitrage traders would be happy to jump in and get a discount on tokens in a LP that doesn’t follow the market price. They drain the token they can sell for more elsewhere and the LP price of both tokens adjusts.
This is theoretically correct. AMM’s dont ‘know’ what token prices are doing elsewhere. If the price they are displaying is wrong, then people will do arbitrage, and it will go back in sync with other exchanges.
So if nobody is making any swaps on that specific pool where you are LPing, then external price movement won’t matter.
You didnt bother going into definitions EITHER tho lol.
You gave one example and didn’t explain why.
? Lol
What if the pair is two stable coins?
practically 0% impermanent loss which is why these pairs are usually the lowest APR
the problem is, you choose an example that serves your purpose. talk about a pair with no stablecoin and IL fears are not overblown… specially with crypto that shoots up
Although in theory you have a well-written, valid point; in practice this can go very badly wrong depending on timing and price movements; I know, because it’s happened to me and I effectively ‘lost’ a good chunk of a stack because the price surged and never came down again (damn you LINK, I love you and hate you for doing that!)
Also many investors don’t consider gas costs for interacting with a smart contract in the first place – depending on what service/network you are using (ERC-20/Ethereum I’m looking at you!!) – the gas fees alone can mean that you have to be investing some pretty big numbers to make it work.
Just be VERY cautious – there’s certainly gains to be had, but LP is far more risky than people realise – they see big APY and get excited, but understand that big price movements and bad timing will wipe out gains quickly, and you can walk away with a far smaller stack than you put in compared to just HODL strategy.
Well, You have a point but if a coin is dropping in value You are fucked. It’s not guaranteed that ones goes up while another stays at the same price which is your worst calculation model in the post.
Hmm, you wrote meaningful information, whole sentences and was not toxic or shouty about it.
That’s not how we do this around here , you are confusing people.
This isn’t going to stop me from commenting ‘Impermanent loss, anyone?’ on any post that has to do with liquidity pairs.
Another thing that can be added onto is that you’ll still be getting rewarded so that 25% loss will be even smaller since you will get some coins in return for providing liquidity.
In fact I feel it’ll be actually better for you if you have tendencies to sell too early as it’ll make it a little more time consuming to well your stake and allow you to hold for longer. This alone might be profitable for you over the longer term even if you take a hit with impermanent loss.
Oops I definitely wanted to mention that somewhere as well!
But you have to remember that most farm tokens will dump hard when the market dumps. So if the markets swings down while you still got farm tokens to harvest or have them staked, you will get spitroasted by impermanent loss and your farm tokens going to shit at the same time
There’s also a lot of dual yield LP’s out there that reward in one of the 2 LP tokens on top of the exchange token (see raydium, trader joe, quickswap, osmosis) further mitigating the risk.
There is nuance to this discussion.
Iet’s say there are two coins you are heavily invested in and truly believe in each coin has a bright future. Then yes, you can LP with some of these coins and the impermanent loss is not so bad because you don’t mind getting stuck with a lopsided amount of either coin and therefore farm them much longer.
However, if you are just chasing juicy APR’s farming shitcoin LP’s, then yes impermanent loss can fuck you up pretty quick if either coin moves fast in any direction
You know the thing about impermanent loss is that, if you are investing in coins you don’t believe in, then when you impermanently ‘lose’ you feel doubly stupid (for both ‘losing’ and expecting a shitcoin to grow).
At least if you invest in coins you believe in, you only feel stupid once.
Similar to buying at the market tanks, selling and the market rises, trying any DeFi will surely create massive impermanent loss. Bad luck has a way of finding us. I’ll stick to DCA, HODL, and Stake lol
It’s not going to be worth it, on its own (might as well hold and do nothing). The only thing that is making it worth it is liquidity mining.
If this is the case it is not really a sign of a healthy economy. I mean if we want to shove to the man, then we should produce a product that actually works and benefit everyone. What good it is if we create an expensive product (it’s not cheap+|slippage) and only makes its backer “lose” money. It is alomst like a lose-lose scenario. It’s like the only thing that makes this works is because of the money printer (someone giving out the liquidity reward that is produced out of thin air).