Thread by @shivsakhuja

Impermanent Loss (IL) is a concept that can be quite tricky to grasp, especially if you’re new to providing liquidity.

I’m going to run through some examples here to illustrate the impact of IL in various scenarios 👇🪡

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First, if you don’t understand how liquidity pools work, you can check out this post which explains.

https://twitter.com/shivsakhuja/status/1473794498081689601?s=21

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A standard liquidity pool (LP) constantly balance your tokens so you always have a 50-50 value.

As the pool balances, the quantities of tokens you own changes.

IL is the risk that you would have been better off holding the 2 tokens, instead of providing liquidity.

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Confused? Let's run through examples.

Let's say you provide liquidity to the $FTM - $ETH pair on @SpookySwap.

For the example, we're going to assume:

• ETH start price = $3,000.00

• FTM start price = $3.00

• Initial investment = $6,000
($3k ETH / $3k FTM)

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Let's evaluate the impermanent loss in these 6 scenarios.

1. FTM 2x, ETH 2x
2. FTM 2x, ETH no change
3. FTM 5x, ETH no change
4. FTM 10x, ETH no change
5. FTM 10x, ETH 3x
6. FTM 0.25x, ETH 0.5x

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1. FTM 2x, ETH 2x.

If you held, you'd have $12,000

If you LPed, you'd end with $12,000 + LP rewards

Impermanent Loss = $0

IL = 0%

If both change by the same %, there is no impermanent loss.

IL depends on the *relative* price change between the two assets in the pair.

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2. FTM 2x, ETH no change

If you held = $9,000

If you LPed = $8,485 + LP rewards

Impermanent Loss = $514

IL = 5.72% (of value if held)

IL is relatively low here, since the value of FTM only doubled relative to the value of ETH.

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3. FTM 5x, ETH no change

If you held = $18,000

If you LPed = $13,416 + LP rewards

Impermanent Loss = $4,583

IL = 25.46% (of value if held)

As you can see, IL is a lot higher here because of the high relative change in the $FTM and $ETH prices.

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4. FTM 10x, ETH no change

If you held = $33,000

If you LPed = $18,973 + LP rewards

Impermanent Loss = $14,026

IL = 42.50% (of value if held)

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5. FTM 10x, ETH 3x

If you held = $39,000

If you LPed = $32,863 + LP rewards

Impermanent Loss = $6,136

IL = 15.73% (of value if held)

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6. FTM 0.25x, ETH 0.5x

If you held = $2,250

If you LPed = $2,121 + LP rewards

Impermanent Loss = $128

IL = 5.72% (of value if held) (same as 2x,2x)

IL is the same even if coins are going down. The important variable is the relative price change between the 2 coins.

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Note that IL % above is calculated against the final value of the tokens if held.

This means that just because you're currently getting 100% APR on a pool doesn't mean it necessarily beats IL of 42.50%.

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For example, in case #4 above, 100% APR on the original invested value would only be $6,000.

But impermanent loss was $14,026.

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Calculating the LP rewards are a bit tricky, because of a few variables.
• APR is not stable, it changes all the time
• Price of tokens
• Price of farm token
• How often you swap farming rewards for stablecoins or other assets

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Generally, if you want to provide liquidity, look for:

• 2 tokens that you are bullish on

• Pairs of tokens that will have low IL (FTM/TOMB, LUNA/bLUNA, ETH/BTC)

• LP / Farming rewards should be greater than IL + staking interest (opportunity cost of holding + staking)

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Another note:

If one coin has a significantly smaller market cap, then IL risk is much higher because the small coins are much more volatile and relative change could be huge.

Typically, these LP farms will have the highest APRs, but also highest risk.

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If you're considering various ways to earn yield through #DeFi, check out this DeFi yield 101 thread:

https://twitter.com/shivsakhuja/status/1480336210887249921?s=20

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Hope this helped.

You can play around with the numbers in this spreadsheet I found on reddit and copied: bit.ly/imp-loss-calc

Thanks anon.