What is impermanent loss?
Impermanent Loss (IL) is a unique risk in the decentralized finance (DeFi) space. It occurs primarily when liquidity providers (LPs) offer assets to automated market maker (AMM) platforms such as Uniswap or SushiSwap.
- Irregular losses arise when the relative prices of the assets in the liquidity pool change.
- An impermanent loss represents a loss compared to holding these assets directly.
What causes impermanent loss?
The cause of the impermanent loss is the change in the relative prices of the assets in the liquidity pool. When an LP deposits two assets into the liquidity pool, the ratio of these assets is dynamically adjusted to maintain a constant product (e.g., in Uniswap v2 the
). If the market prices of the two assets change, the allocation of assets in the pool is adjusted accordingly, which may result in a loss compared with holding the assets outright.
示例
- Initial state: deposit 1 ETH and 100USDT(Assuming 1 ETH = 100 USDT).
- Price change: ETH price increased to 1 ETH = 150 USDT.
- Rebalancing: the liquidity pool adjusts the proportion of assets to maintain a constant product formula
。 - Withdrawal of assets: You withdraw about 0.82 ETH and 123 USDT, for a total value of
USDT。 - Direct holding value:
USDT。 - Difference: Irregular loss of
USDT。
Main features
- Impermanence: If the price returns to its original rate, the impermanent loss will disappear, which is why it is called “impermanent”.
- Affected by the magnitude of price changes: the greater the price fluctuation, the greater the impermanent loss.
- Fee compensation: The transaction fee earned by the liquidity provider (e.g., 0.3%) may offset or even exceed the impermanent loss.
formulas
- Estimate the impermanent loss using the formula:
which
。 - 当
When the impermanent loss is 0 (no price change). - 当
When the impermanent loss is positive, it represents a loss.
How to Reduce Irregular Losses
- Selection of low volatility pairs: Providing liquidity to a liquidity pool of stabilized assets (e.g. USDC/USDT) reduces impermanent losses.
- Earn higher fees: participate in pools with active trading and offset losses through fee income.
- Consider other protocols: Certain protocols (e.g., Balancer or Curve) allow for asymmetric liquidity provision, which can further reduce risk.
Impermanent loss is a key to liquidity mining in DeFi风险. It is critical to understand the impacts and coping strategies before engaging.
Why wouldn’t an impermanent loss be negative?
An impermanent loss is always relative to a directly held asset:
- Decrease in the number of assets held: The constant product formula in the liquidity pool (e.g.
The proportion of assets is adjusted when prices fluctuate. For example, higher-priced assets will decrease and lower-priced assets will increase. - Difference in value: The total value of the adjusted portfolio is lower than the value of the original portfolio held directly. As a result, there is only a loss, not a “negative loss” or additional gain.
Possible misinterpretation: handling fees to offset losses
Although the impermanent loss will not be negative, liquidity providers can earn additional revenue through transaction fees that partially or even completely offset the impermanent loss. In some cases:
- Handling fee gains > Uncommon losses: Positive overall gains.
- However, this does not mean that the “loss of impermanence becomes negative”, but because of the effect of the commission.
The math and mechanics of impermanent loss dictate that it will not be negative, but the impact of impermanent loss on profitability can be indirectly reduced by strategies (e.g., selecting low-volatility asset pairs and high volume pools) that allow for positive overall returns.
English:Introduction to Impermanent Loss
blockchain technology
- Synopsis: Impermanent Loss in Blockchain DeFi Transactions
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- Steem to Wavefield U Trust Issues (Steem/SBD to USDT TRC-20)
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Synopsis: Impermanent Loss in Blockchain DeFi Transactions. (AMP Mobile Accelerated Version)
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