Thread by @korpi87

Do long-term liquidity providers (LPs) to AMMs earn passive income? What is their ROI when the impact of impermanent loss (IL) is included?

I compared LPing on Uniswap and Bancor to check if IL-protection from Bancor is a useful feature for LPs.

See 🧵for more alpha!

$UNI $BNT

TL;DR:

- LPs on Uniswap often end up with less money than they would have by “hodling”, while LPs on Bancor always outperform a buy-and-hold strategy when full IL protection is achieved.
- IL protection is a killer feature for passive income generation.

korpi.medium.com/understand-ban…

1) LPing involves investors lending their idle assets to an AMM in anticipation of passive returns from trading fees. Although trading fees do generate a revenue stream for LPs, it’s not always guaranteed passive income. It would be, were it not for the infamous impermanent loss.

2) IL is the difference in value between holding tokens in an AMM liquidity pool and holding them in a wallet. This difference can be either equal to 0 (no IL) or negative (IL). IL can't be avoided and it results from the AMM design.

Read more about IL:

https://twitter.com/korpi87/status/1372634330451836929

3) IL is dependent on the price ratio between two tokens in the pool. The bigger the divergence between the current price ratio and the initial price ratio, the greater the IL. However, if the price ratio returns to the initial state, IL disappears. That's why it's "impermanent".

4) There are a few ways LPs can mitigate IL by taking a more active approach to LPing, however, none of them guarantee they will not suffer from IL and eventually incur a net loss from LPing.

I described a few mitigation strategies in my thread on IL:

https://twitter.com/korpi87/status/1372634338181939206

5) The dirty secret of most AMMs is that IL often becomes permanent and because of that many LPs underperform a simple buy-and-hold strategy. The expected passive income from LPing becomes a net loss.

It's fair to say that IL protection must be a killer feature for passive LPs.

6) While AMM design makes it impossible to eliminate IL, it is possible to transfer and distribute this risk. That is Bancor’s unique value proposition.

Bancor eliminates IL for LPs by shifting the risk to the protocol itself.

More about IL protection: docs.bancor.network/faqs#how-does-…

7) LPs on Bancor always outperform a buy-and-hold strategy (when full IL protection is achieved after 100 days) which is far from guaranteed in other AMMs. IL-protected pools on Bancor are, therefore, an attractive and risk-free source of passive income for LPs.

8) “But ser? You promised an analysis not a lecture!” OK. Let's get into it.

I used historical data to compare the performance of two strategies: LPing in IL-protected pools on Bancor and LPing in IL-exposed pools on Uniswap. It was my quest of a passive income strategy for LPs.

9) I only analysed tokens which had IL protection from the early days of Bancor v2.1 to have as long a time period as possible. This led me to the following choices:
- Tokens: $LINK, $LRC, $MKR, $MTA, $OMG, $REN, $renBTC, $RSR
- Time period: 2020/11/01 - 2021/06/26

10) I used amm.vav.me to plot graphs of percentage returns vs a buy-and-hold strategy.
- Left graph - IL-exposed pool on Uniswap
- Right graph - IL-protected pool on Bancor
- 🟦 Collected Fees
- 🟥 IL
- 🟩 Pool Return = 🟦+🟥
- 🟨 IL-Protected Return on Bancor

11) The purpose of this analysis is to find a better strategy for passive LPs. While LP ROI on Uniswap is the same as Pool Return 🟩, on Bancor LP ROI is represented by IL-Protected Return 🟨. Uniswap 🟩 and Bancor 🟨 are the curves which should be compared from LP perspective.

12) Graphs with the comparison of percentage returns vs a buy-and-hold strategy between IL-exposed pool on Uniswap (left graph) and IL-protected pool on Bancor (right graph) for the following tokens: $LINK $LRC $MKR $MTA

13) Graphs with the comparison of percentage returns vs a buy-and-hold strategy between IL-exposed pool on Uniswap (left graph) and IL-protected pool on Bancor (right graph) for the following tokens: $OMG $REN $renBTC $RSR

14) Main conclusions from the graphs:
- IL is often permanent. Only $MKR LPs were lucky to experience impermanent nature of IL.
- IL is a substantial risk for LPs. For most analysed pools IL outstrips returns from fees.
- IL makes it hard for LPs to exit the pool when they want.

15) If we compare LP ROI on the end date of the analysis period, we have some interesting findings:
- ROI for Uniswap LPs is highly volatile and often negative. Only 3 out of 8 pools earned profits for LPs.
- Bancor LPs have guaranteed profits when full IL protection is accrued.

16) Although returns from fees alone on Uniswap are higher than on Bancor, it doesn’t imply higher net returns for LPs. In spite of higher fees APR, most Uniswap LPs underperformed not only Bancor LPs but also a buy-and-hold strategy because of the impact of IL.

17) Important lesson:

Watch out for APR for IL-exposed pools!

Advertised APR figures for traditional AMMs ignore the impact of IL and, therefore, are misleading indicators of future returns. Real net returns for LPs are often much lower, even negative, because of IL.

18) Two main conclusions from the conducted analysis:
- Uniswap returns are not guaranteed. Because of IL, LPs often end up with less money than they would have by “hodling”.
- Due to IL protection, Bancor guarantees long term LPs positive returns vs a buy-and-hold strategy.

19) While Uniswap is an option for investors with a bigger risk appetite, Bancor should be the obvious choice for passive LPs who want to book guaranteed profits. Moreover, Bancor makes it maximally easy to become an LP.

20) LPs in other AMMs are always forced to maintain exposure to both assets in the pool, whereas on Bancor you can provide liquidity in a single asset only. Any investor who wants to hold a long position on the preferred asset can become an LP on Bancor.

21) Single-sided exposure combined with IL protection turns Bancor pools into interest-bearing accounts for token holders. Depositors on Bancor always have guaranteed profits vs a buy-and-hold strategy and this is what other competitive AMMs don’t offer.

Thanks for your time! If you find this thread valuable, please retweet it to spread the good LP practice with more DeFi users.

The thread is just a "short" summary of the full post on my Medium. If you fancy more details and insights, give it a read:
korpi.medium.com/understand-ban…

If you've got Bancor-pilled, you may enjoy my thread on the nuances of the $BNT supply and its impact on the BNT market cap. Watch out for some alpha leaks!

https://twitter.com/korpi87/status/1405847204095537157

This thread is another piece in a series of educational materials I'm preparing within the framework of my partnership with Bancor. My mission is to share Bancor's unique value propositions with a wider audience. Please help me reach this target by sharing. Thanks!