Try Quests to earn cryptoEthereum Uniswap Pools: Impermanent Loss
In this dashboard, we will be looking into the Analysis of Impermanent Loss while participating in the below Top WETH Uniswap Pools versus Just Holding the Tokens.
USDC-WETH || WETH-USDT || WBTC-WETH || UNI-WETH || DAI-WETH || MATIC-WETH
Select a POOL from the above drop down pool_name and click on Apply All Parameters button to look into the
Total Volume of Tokens LP’ed into the Pool
Price Comparison of Tokens within the Pool
The Impermanent Loss while participating in the POOL vs just Holding the Tokens
What is Impermanent Loss?
One of the risks associated with liquidity pools is impermanent loss. This occurs when the price ratio of pooled assets fluctuates. An LP will automatically incur losses when the price ratio of the pooled asset deviates from the price at which he deposited funds. The higher the shift in price, the higher the loss incurred. Impermanent losses commonly affect pools that contain volatile digital assets.
However, this loss is impermanent because there is a probability that the price ratio will revert. The loss only becomes permanent when the LP withdraws the said funds before the price ratio reverts. Also, note that the potential earnings from transaction fees and LP token staking can sometimes cover such losses.
Calculation of Impermanent Loss:
Most AMM and liquidity pool uses the below constant product formula that mathematically determines what the market price of the token in the pool should be.
x * y = k
In our scenario x = VELO liquidity pool, y = Token liquidity pool and k = constant product
We can rearrange the equation of the formula to better understand the impact on LP.
VELO price = y / x
x (VELO liquidity pool) = sqrt(k / VELO price)
y (Token liquidity pool) = sqrt(k * VELO price)
In short, Impermanent Loss refers to the situation where you could have made more should you have done nothing and HODL rather than providing LP. The impermanent loss is calculated as the difference between the value of tokens when not in the pool and the one in the pool as a liquidity provider at T2.
With the same logic above, we could derive the formula for the size of the impermanent loss in terms of the price ratio between when liquidity was supplied and now. If you are interested in the derivation process, you could look into the below article
.
Where LR is the Impermanent Loss Ratio, p1 and p2 are the price at the Time of T1, T2 respectively.
What is Liquidity Providing ?
What/Who is a Liquidity Provider?
A liquidity provider, also known as a market maker, is someone who provides their crypto assets to a platform to help with decentralization of trading. In return they are rewarded with fees generated by trades on that platform, which can be thought of as a form of passive income.
It is important to note that the assets provided are locked with the platform for the amount of time the user decides to provide liquidity.
What is a Liquidity Pool?
The quantity provided by you would be in the form of a token pair, which are locked in smart contracts and are used to provide liquidity. The liquidity you provide is deposited into a liquidity pool, which is used in most cases, by decentralized exchanges. A liquidity pool is designated by the token pair it represents. For example, ETH-USDC is a liquidity pool that contains the liquidity provided for the token pair ETH and USDC.
Why do we need Liquidity Pools?
To better understand the concept of liquidity pools, we need to understand the concept of Automated Market Makers.
An Automated Market Maker (AMM) is the underlying protocol that powers all decentralized exchanges (DEXs), DEXs help users exchange cryptocurrencies by connecting users directly, without an intermediary. Simply put, automated market makers are autonomous trading mechanisms that eliminate the need for centralized exchanges and related market-making techniques.
Unlike centralized exchanges, DEXs look to eradicate all intermediate processes involved in crypto trading. They do not support order matching systems or custodial infrastructures. As such, DEXs promote autonomy such that users can initiate trades directly from non-custodial wallets.
Also, DEXs replace order matching systems and order books with autonomous protocols called AMMs. These protocols use smart contracts – self-executing computer programs – to define the price of digital assets and provide liquidity. Here, the protocol pools liquidity into smart contracts. In essence, users are not technically trading against counterparties – instead, they are trading against the liquidity locked inside smart contracts. These smart contracts are often called liquidity pools.
From the above graph, for all the Pools selected, we can see that the Pool USDC-WETH has the MORE Liquidity Provided by the Tokens and the Pool MATIC-WETH has the LESS Liquidity Provided compared to the other Pools in the drop down.
The final step is to Calculate the Impermanent Loss Ratio for both the Tokens if its Held rather than LPed into the Pools. For this, we use the LR(Impermanent) Formula that is shown above in the section Calculation of Impermanent Loss.
The below Line Charts and Area Charts shows us the
Impermanent Loss Ratio of Token comparing with the Two Token Prices in the Selected Pool by Day-Wise
Impermanent Loss Percentage while participating in the selected POOL vs Holding the Token.
Variation of Impermanent Loss for each Pool:
In the above charts, the Impermanent Loss is calculated by considering January 1st as the Start Time (T1) and every other day as End Time (T2). So let’s consider an User deposits the Tokens into the Pool on January 1st and then we will be looking into the details of how is the variation of Impermanent Loss on Daily basis upto now.
In the Pool USDC-WETH, we can see that the Percentage of IL in gradually increased from January and we observe almost 2.5% of IL at the ending of January. From May 6th, we see the exponential growth where it reaches to 18.5% IL on June 18th, 2022. Then it fluctuates between 16-18 upto Mid-July and then decreases to 4.7% at the mid-august and then we see some fluctuations. Currently from last 10 days, we see the IL is around 12%.
In the Pool WETH-USDT, as USDT price is almost equal to the USDC price, the chart of IL Percentage for WETH-USDT is similar to USDC-WETH. There may be difference in decimals but everything remains same.
In the Pool WBTC-WETH, we can see that the IL % reaches to first highest 0.4% at the end of January and again it decreases to 0.1% by the first week of February. It reaches the second peak of 0.45% on March 9th and then decreased to 0.02% by April first week. This runs in constant manner upto Mid-May and then we see exponential growth to 2.1% on June 13th and June 18th. We can also see two more peaks at 1.8% on June 30th and 1.7% on July 13th, then a sudden decrease to 0.005% on August 11th and continues in the same trend upto September 15th. From the last 10 days, the IL % is trending around 0.25%.
In the Pool UNI-WETH, we can clearly see that there is gradual increase in the IL % from January to April. We see it reaches to 1% on February 21st and 2% on April 11th. There is exponential increase of IL % in the last week of April where it reaches from 2% on April 23rd to 4.7% on May 2nd. Then all of a sudden it falls to 3% on May 9th and it reaches the peak of 5.5% on May 12th. Gradually it decreases to 0.02% on June 23rd and then we see minor peaks but didn’t exceed 0.5% upto now. Currently from last 10 days, it is at 0.02%.
In the Pool DAI-WETH, there is gradual increase in the IL % from January to May from 0% to 6.5%. From June 9th to June 19th, there is exponential growth in the IL from 6.2% to 18.5% and it fluctuates between 16%-17% upto July 13th. Then, there is sudden decrease to 9% from July 13th to July 19th and it reaches to the very low position of 4.7% IL on August 15th. Then the trend is fluctuating between 8%-10% upto September first week, then suddenly decreased to 6.8% on September 12th and then increased to 12.8% on September 22nd. Currently it is trending around 12% IL.
In the Pool MATIC-WETH, we see the gradual increase of IL % to 4.1% on May 10th and sudden increase to 7.6% on May 12th. Then it fluctuates around 6.5% upto June 9th and there is sudden decrease to 1% on June 24th. It decreases more to 0.25% on July 19th and then we see small peaks between 1%-2%, From the last 10 days, the IL % is trending around 0.5%.
Summary
This dashboard is to mainly provides us the Calculation of Impermanent Loss for Tokens while participating in the Pools versus just Holding it in the Account. We can also look into the Variation of Impermanent Loss Percentage on Day-wise for the selected POOL from the drop down.
From all the above charts, we can conclude that:
- Currently, the Impermanent Loss is trending as low for UNI-WETH & WBTC-WETH Pools. The IL % is very high for USDC-WETH, WETH-USDT & DAI-WETH Pools.
- Between the time period of May to July, we see high peaks of Impermanent Loss for all the Pools.
On a Final Note, For the months of May, June, July in 2022, along with the WETH, it would be better to LP’ing WBTC & UNI rather than holding them in the wallet. But for the other tokens like USDC, USDT, DAI & MATIC, it would be better holding them in the wallet. But currently, almost for all the pools, the Impermanent Loss is very low and LP’ing into all the pools is better compared to the previous quarter.