So why do liquidity providers still provide liquidity if they’re exposed to potential losses? Well, impermanent loss can still be counteracted by trading fees. In this case, there’s a smaller risk of impermanent loss for liquidity providers (LPs). Stablecoins or different wrapped versions of a coin, for example, will stay in a relatively contained price range. Pools that contain assets that remain in a relatively small price range will be less exposed to impermanent loss. In this case, the loss means less dollar value at the time of withdrawal than at the time of deposit. The bigger this change is, the more you are exposed to impermanent loss. Impermanent loss happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them. So, what do you need to know if you want to provide liquidity for these platforms? In this article, we’ll discuss one of the most important concepts – impermanent loss. Democratizing market making has enabled a lot of frictionless economic activity in the crypto space. These liquidity protocols enable essentially anyone with funds to become a market maker and earn trading fees. Providing liquidity to a liquidity pool can be a profitable venture, but you’ll need to keep the concept of impermanent loss in mind.ĭeFi protocols like Uniswap, SushiSwap, or PancakeSwap have seen an explosion of volume and liquidity. Wait, so I can lose money by providing liquidity? And why is the loss impermanent? Well, it comes from an inherent design characteristic of a special kind of market called an automated market maker. The larger the change is, the bigger the loss. Impermanent loss happens when the price of your tokens changes compared to when you deposited them in the pool. If you’ve been involved with DeFi at all, you almost certainly heard this term thrown around.
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