What is impermanent loss?

Impermanent loss occurs because of three factors:

1. Crypto market volatility
2. AMM pricing algorithms
3. LP token redemption

During periods of high volatility, the market prices of assets deposited in a liquidity pool can change.

The change might arise from several factors, such as a project reaching a certain roadmap milestone, launching new partnerships, and other factors that affect the future outlook of the protocol. 

Price volatility can also be caused by negative outcomes that cause the price of the asset to decrease. Crypto markets can be volatile and sentiment about an asset changes rapidly. In turn, these price changes can contribute to impermanent loss.

Most AMM pricing algorithms maintain a fixed 50/50 ratio of assets in the pool, such that the USD value of both assets must equal the same value.

As an example, an ETH/DAI pool with a total value locked (TVL) of $100,000 would contain $50,000 worth of ETH and $50,000 worth of DAI at its current US dollar value.

To maintain this ratio in accordance with the market, the AMM pricing algorithm automatically adjusts the prices of the paired assets within the pool.

During periods of high volatility, this can sometimes mean prices of assets held in a liquidity pool are cheaper or more expensive than their present market value.

When this happens, the discrepancy attracts arbitrage traders who aim to earn a profit by removing the discounted assets from the liquidity pools and adding the other paired asset to the pool.

Arbitrage traders continuously participate in this process in order to earn a profit from keeping the value of paired assets in the pool aligned with current market prices.

When a liquidity provider wishes to withdraw their paired assets from the pool, they must burn their LP tokens. 

LP tokens represent a LP’s percentage share of the assets in the pool. They do not represent the exact amount of assets the LP originally deposited.

This factor means that LPs are not guaranteed to receive the exact same amount of assets they deposited. Instead, the amount they recieve back depends on the total value of the liquidity pool, the prices of the assets held within that pool, and what their individual percentage share of the full pool equals.

The complex nature of how impermanent loss can occur makes participating in liquidity pools an important decision for any crypto trader.

Those first entering the crypto space should first understand the nuances and risks of decentralized finance before depositing funds in liquidity pools.

Si bien la pérdida impermanente es un riesgo inherente asociado a la provisión de liquidez, existen varias estrategias que pueden ayudar a los traders y proveedores de liquidez a mitigar su impacto:

• Selección de pares: Elegir pares de activos digitales con menor volatilidad de precios puede reducir el riesgo de pérdida impermanente. Los pares muy volátiles tienen más probabilidades de experimentar divergencias de precios significativas y, por tanto, suponen un mayor riesgo de incurrir en una pérdida impermanente.
• Criptomonedas estables: Los proveedores de liquidez pueden optar por pares con stablecoins en los que uno de los tokens es una stablecoin con un valor relativamente constante. Esta estrategia reduce el riesgo de pérdidas impermanentes, ya que las criptomonedas estables suelen registrar menos fluctuaciones de precio.
• Cobertura: Algunos proveedores de liquidez cubren sus posiciones operando simultáneamente con los tokens para los que proporcionan liquidez en otras plataformas. Esta estrategia suele ayudar a compensar las posibles pérdidas debidas a la divergencia de precios. Puedes consultar nuestro artículo del Centro de aprendizaje de Kraken ¿Qué es la cobertura? si quieres saber más.
• Yield farming e incentivos: Algunas plataformas ofrecen recompensas adicionales a las comisiones de trading, como tokens de gobernanza, a cambio de proporcionar liquidez. Estos incentivos complementarios que proporciona el protocolo pueden ayudar a compensar los riesgos potenciales de pérdidas impermanentes.
• Supervisión y ajuste periódicos: Comprobar regularmente el estado del grupo de liquidez puede ayudar a minimizar el impacto de las pérdidas impermanentes. Existen diversas herramientas y servicios automatizados que pueden ayudar en este proceso.
• Diversificación: En lugar de proporcionar liquidez a un único grupo, la diversificación entre varios grupos y tipos de criptomoneda puede ayudar a distribuir el riesgo de pérdida impermanente.
• Perspectiva a largo plazo: Si los proveedores de liquidez están dispuestos a mantener sus activos digitales durante un período prolongado, las pérdidas impermanentes podrían verse compensadas con el tiempo por las comisiones de trading y la posible revalorización de los tokens.

La pérdida impermanente es un concepto que todos los proveedores de liquidez en DeFi deberían tener en cuenta.

Con una comprensión clara de cómo se produce la pérdida impermanente y un enfoque cauteloso de la gestión de riesgos, los traders y los proveedores de liquidez pueden tratar de minimizar los efectos de la pérdida impermanente a medida que se adentran en el mundo cambiante de la financiación descentralizada.

An example of impermanent loss might look like this.

A DeFi user wishes to provide liquidity to an ETH/USDC pool. In order to provide liquidity, the must deposit equal values of both assets in the liquidity pool, given their current market price

If the price of ETH is $1,500 when the liquidity provider is looking to deposit ETH in the pool, they would also need to contribute $1,500 worth of the USDC stablecoin for each ETH coin they deposit

In this example, let’s say the liquidity provider deposits 2 ETH and 3,000 USDC into the ETH/USDC liquidity pool.

Let’s also say that the liquidity pool holds 40 ETH and 60,000 USDC in total, meaning the user's deposited assets equals 5% of the total value of the pool.

Over time, ETH price may change in value compared to USDC. For this example, let’s say the market price of ETH has doubled in value, and is now worth 3,000 USDC.

There is now a sizable discrepancy between the market price of ETH and the price of ETH in the liquidity pool.

Some traders recognize the arbitrage opportunity and begin adding USDC to the pool to remove the discounted ETH coins. Eventually, the pool rebalances, making the total value of the remaining ETH in the pool equal the same as its value in USDC.

However, after arbitrageurs rebalance the pool, it now contains 28.28 ETH and 84,852.81 USDC.  The 28.28 ETH at its new price of $3,000 equals $84,852.81, which is the same value as the number of USDC tokens in the pool.

Anyone can calculate their potential liquidity mining risk using online impermanent loss calculators.

If the liquidity provider decided to withdraw their share of the pool, they would realize a loss of 5.72% compared to if they had simply held their crypto assets and not provided liquidity to the pool.

However, they would also earn a portion of the fees that trading within the pool generated. Depending on how much they earned for providing liquidity, these fees may or may not offset the impact caused by impermanent loss.

It's important to note that impermanent loss is "impermanent" because it only becomes realized if the user withdraws their liquidity when the prices have moved unfavorably. If the user waits, and the prices revert or balance out, the impermanent loss may decrease or disappear.

Ahora que ya conoce el concepto de pérdida impermanente y el apasionante mundo de la financiación descentralizada, ¿está en condiciones de dar el siguiente paso en su andadura criptográfica?

Kraken le permite comprar, vender e intercambiar las principales criptomonedas que conforman el ecosistema de DeFi.

Regístrese hoy mismo en Kraken para iniciarse en el apasionante mundo de la financiación descentralizada.