In a sense, this is similar to what liquidity providers in AMM protocols experience with Impermanent Loss. If the price moves sharply in one direction, you lose out — at least in the short term — on potential gains. AMMs are software-controlled, autonomous decentralized exchanges where the prices of the assets held in a trading pool are controlled by an underlying algorithm.

To overcome this limitation, platforms such as Balancer offer pools with different weights and a variable number of assets. For instance, one of the most popular pools on Balancer is BAL-ETH, where the weight of the BAL side of the pool is 80%. This means that changes in the price of ETH (positive or negative) will not affect the pool that much compared to a 50/50 split. Let’s go through an example of how impermanent loss may look like for a liquidity provider.

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But in the case of V3, things are a bit more complicated, given the nature of concentrated liquidity. Pools such as sETH/ETH on Uniswap or stablecoin AMMs like DAI/USDC/USDT/sUSD on Curve contain assets that will stay relatively stable with each other. Automated Market Makers (AMMs) were first described in 2016 by Ethereum co-founder Vitalik Buterin on Reddit as a way to simplify on-chain market making on the Ethereum blockchain.

• There are also AMMs with a single asset type, where you can give a stablecoin to the pool to ensure its solvency.
• If there’s a lot of trading volume happening in a given pool, it can be profitable to provide liquidity even if the pool is heavily exposed to impermanent loss.
• In essence, impermanent loss is a temporary loss of funds occurring when providing liquidity.
• For instance, when the price of Ethereum increases, traders can purchase ETH at a lower rate on one exchange and sell it for higher on others.
• So if you want to earn commissions like LP but don’t mind a lot of IL, these liquidity pools can be a good option.

A liquidity pool typically has two tokens, referred to as token pairs. Now, these tokens need to be equal in ratios to make it simpler for users to trade. Here, the ratio of the total value of each token will be 50% of ETH and 50% of USDT.

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In short, if the price of the deposited assets changes since the deposit, the LP may be exposed to impermanent loss. It’s called impermanent loss because the losses only become https://www.xcritical.com/ realized once you withdraw your coins from the liquidity pool. The fees you earn may be able to compensate for those losses, but it’s still a slightly misleading name.

KyberSwap powers 100+ integrated projects and has facilitated over US$20 billion worth of transactions for thousands of users since its inception. Currently deployed across 14 chains including Ethereum, BSC, Arbitrum, Polygon, Optimism, Avalanche, Cronos, zkSync Era, Fantom, Aurora, Linea, BitTorrent, Velas, and Oasis. If John stakes 1 ETH and 100 USDC where the tokens staked are equivalent to the equal value, then 1 ETH equals 100 USDC.

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Below is another example of an impermanent loss calculator that can be found at decentyields.com/impermanent-loss-calculator. Here you can manually set your deposit amount as well as the ratio of the pool, the pool weight. Impermanent Loss refers to the theoretical loss of value a liquidity provider can experience when pooling their assets. 1 BNB token https://www.xcritical.com/blog/what-is-liquidity-mining/ is suddenly worth only 15 CAKE tokens because of CAKE’s price jump. However, because the protocol has automatically adjusted the amount of tokens held in the pool, you lost out on the CAKE rally. In this article, we explain what Impermanent Loss is, and how it creates a risk to liquidity providers, and provide some solutions to mitigate this risk.

Formula (5) will work for standard pools as well — you just need to use 0.5 for both weights. Impermanent loss threatens the promise of AMMs as a mechanism for democratizing liquidity provision. Finder.com is an independent comparison platform and
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If there’s a lot of trading volume happening in a given pool, it can be profitable to provide liquidity even if the pool is heavily exposed to impermanent loss. This, however, depends on the protocol, the specific pool, the deposited assets, and even wider market conditions. On top of that, a lot of liquidity pools provide additional incentives for LPs by offering liquidity mining programs.