Comrades who are new to the cryptocurrency circle often ask me a question:
Xiaoxiong, I see that Earn on @PancakeSwap is profitable. If I save money there, I can get a 280% return rate, which means I can triple my money in one year. What the hell am I trading? How fast can I do it?
Wait a minute, brother, do you know what impermanent loss is?
Bear gives an example
Li Ergou formed an LP in Pancake and provided $10,000 and an equivalent amount of $PLAY to the PLAY/USDC liquidity pool.
One month later, the price of PLAY fell by 50%, but the price of USDC remained unchanged. Due to the pool balance caused by arbitrage, the amount of USDC in Li Ergou's pool will decrease, and all of it will be automatically bought into PLAY for him. Then PLAY fell by half, and he suffered a big loss. This is the impermanent loss he suffered.
Therefore, when you see a super high-yield altcoin pool, don’t easily form an LP. Do your research first to avoid losses.
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Let's learn systematically what impermanent loss is.
1 Introduction
Temporary loss is a concept unique to liquidity pools in decentralized finance, particularly those in automated market makers (AMMs) like Uniswap, SushiSwap, and Balancer.
While the word “temporary” implies a temporary state, this loss can become very real and permanent if not properly understood and managed.
2. What is impermanent loss?
Impermanent loss occurs when the price of tokens in a liquidity pool deviates from their initial deposit value, potentially resulting in losses rather than just holding them. In an automated market maker (AMM), arbitrageurs adjust the balances in the pool when the price of external tokens rises. This can result in providers holding fewer tokens that have risen and more tokens that have fallen.
3. Why is it important?
Potential for losses: When tokens are removed from the pool (e.g. when a liquidity provider decides to stop providing liquidity), the loss becomes permanent if the price of the token diverges from the initial deposit price. Contrast with holding: In volatile market conditions, liquidity providers may find it more effective to hold tokens directly rather than provide liquidity.
4. Quick Example:
USDC-ETH Pool Initial deposit: 1ETH (worth 2000 USDC) and 2000 USDC.
Total value: 4000 USDC
Price Change: ETH Doubles to 4000 USDC Elsewhere
Pool balance after arbitrage: Due to arbitrage, the pool may be adjusted to 0.7071 ETH and 2828.45 USDC
Value calculation: When no liquidity is provided: 1ETH (4000 USDC) + 2000 USDC = 6000 USDC
Liquidity pool share: 0.7071 ETH (2828.45 USDC) + 2828.45 USDC = 5656.9 USDC
Impermanent loss: The difference between just holding assets (6000 USDC) and providing liquidity (5656.9 USDC) is 343.1 USDC.
This 343.1 USDC is your impermanent loss.
This knowledge point is provided by @CIAN_protocol Defi Class #LearnwithCIAN
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End of article
