Impermanent Loss is one of the most important and the concepts in DeFi. Let's spend some time to understand how @Bancor V3 addresses it.
Time for a thread ππ§΅π
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Time for a thread ππ§΅π
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Impermanent Loss is the main risk for liquidity providers.
Itβs defined as the difference in value between providing liquidity to a pool and simply holding the tokens in a wallet.
Confused? Letβs take an example π
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Itβs defined as the difference in value between providing liquidity to a pool and simply holding the tokens in a wallet.
Confused? Letβs take an example π
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Suppose a user wants to provide liquidity for the ETH/USDC pair.
Letβs suppose that the price of $ETH is $2000 and the user wants to deposit 50,000 $USDC and 25 $ETH in the pool for the total value of $100,000 as we supposed this a 50/50 pool.
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Letβs suppose that the price of $ETH is $2000 and the user wants to deposit 50,000 $USDC and 25 $ETH in the pool for the total value of $100,000 as we supposed this a 50/50 pool.
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Suppose $ETH price increases by 10% so itβs $2200 now.
An arbitrage opportunity emerges to rebalance the pool and other users want to take advantage of it.
The pool is described by the following equation:
X * Y = constante.
X = Amount of $ETH
Y = Amount of $USDC
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An arbitrage opportunity emerges to rebalance the pool and other users want to take advantage of it.
The pool is described by the following equation:
X * Y = constante.
X = Amount of $ETH
Y = Amount of $USDC
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The constant is equal to 50000 * 25 = 1,250,000 .
This 1,250,000 number should be maintained.
If the amount of X decreases the value of Y must increase in order to maintain the validity of the equation.
After the arbitrage the price of $ETH is $2200.
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This 1,250,000 number should be maintained.
If the amount of X decreases the value of Y must increase in order to maintain the validity of the equation.
After the arbitrage the price of $ETH is $2200.
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Letβs now calculate how many of each token, $USDC and $ETH, the liquidity provider has in the pool.
We have 2 equations
1β£ X * Y = 1,250,000.
2β£ X * 2200 = Y .Since itβs a 50/50 pool in dollar value.
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We have 2 equations
1β£ X * Y = 1,250,000.
2β£ X * 2200 = Y .Since itβs a 50/50 pool in dollar value.
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From the two equations and after some eliminations. We get the following equation:
β X^2 * 2200 = 1,250,000
So X which is the amount of $ETH left in the pool is 23.84 $ETH.
And the equivalent $USDC amount Is:
23.84*2200= 52,448.
Now the poolβs value is: $104,896.
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β X^2 * 2200 = 1,250,000
So X which is the amount of $ETH left in the pool is 23.84 $ETH.
And the equivalent $USDC amount Is:
23.84*2200= 52,448.
Now the poolβs value is: $104,896.
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Had the liquidity provider kept his tokens in the wallet and not provided liquidity, the value would have been: $105,000.
The difference of $104 is whatβs called the impermanent loss.
This loss becomes permanent when the funds are withdrawn from the pool.
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The difference of $104 is whatβs called the impermanent loss.
This loss becomes permanent when the funds are withdrawn from the pool.
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Now that we understand impermanent loss, letβs see how @Bancor addresses it in V3 with the impermanent loss protection.
This protection ensures that the liquidity provider is given back the tokens with the same value as he would have kept them in his wallet.
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This protection ensures that the liquidity provider is given back the tokens with the same value as he would have kept them in his wallet.
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The fees earned by the protocol are used to compensate the liquidity provider from impermanent loss.
In V3 the liquidity provider is compensated for 100% of the impermanent loss. There is 0.25% withdrawal fee and 7 days cool down period when withdrawing.
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In V3 the liquidity provider is compensated for 100% of the impermanent loss. There is 0.25% withdrawal fee and 7 days cool down period when withdrawing.
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By eliminating the biggest risk liquidity providers face, @Bancor V3 allow users to stake with confidence and achieve the deep liquidity required for DeFi to work properly.
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