Impermanent Loss w Liquidity Pool?

Hello everyone,

I am stoked because this is the first post I’ve made directly from the app! Good stuff. Keep it up team really loving how active y’all are.

I was just wondering if adding liquidity to an incognito pool would open one up to impermanent loss? I’ve been using a few defi protocols recently and still haven’t really grasped the impermanent loss concept 100% so I was just wondering if this might ever happen?

Thanks a lot and stay Incognito.

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Hey @walkonwayvs, I think this topic might be a helpful reference for you Impermanent Loss - Liquidity providers must know. :wink:

The impermanent loss is not so difficult to understand after a while. Let me show you with another example with more formulas (based on this post):

Suppose that you want to provide liquidity to the PRV/USDC pair and at the time you add the liquidity, the exchange rate is 1 PRV = 1 USDC. If you want to provide 100 USDC, 100 PRV must be paired.

The underlying model is based on:
constant_product = prv_liquidity_pool * uscd_liquidity_pool = 100 * 100 = 10 000

And since:
prv_price = usdc_liquidity_pool / prv_liquidity_pool = 100 / 100 = 1.00

Combining the above to equations we have:
prv_liquidity_pool = sqrt(constant_product / prv_price) = 100.00
usdc_liquidity_pool = sqrt(constant_product * prv_price) = 100.00

Later, the price changes, so 1 PRV = 1.2 USDC. The liquidity pools must change, since the constant cannot:

prv_price = 1.20
prv_liquidity_pool = sqrt(constant_product / prv_price) = 91.29
usdc_liquidity_pool = sqrt(constant_product * prv_price) = 109.54
constant_product = prv_liquidity_pool * uscd_liquidity_pool = 91.29 * 109.54 = 10 000

That is the logic for the liquidity pool, but what about the impermanent loss?

Originally you had 100 PRV and 100 USCD, converting all to USDC, with the current price, you would have:
(100 PRV @ 1.2 USDC = 120 USDC) + 100 USDC = 220 USDC

But in the liquidity pool you have:
(91.29 PRV @ 1.2 USDC = 109.54 USDC) + 109.54 USDC = 219.09 USDC

That difference is the impermanent loss. It is impermanent because if the exchange rate comes back to 1 PRV = 1 USDC, there is no loss.


But if you must wait the exchange rate to get back to the original one to avoid the loss, why would anyone want to be locked as a liquidity provider for an unknown amount of time?

Hope it helps.

3 Likes

Hey @walkonwayvs,

With incognito DEX, there are two options to provide liquidity. Provide and Add functionality

image

Difference

Add

  1. If you add liquidity you must submit both tokens at once
  2. You will experience impermanent loss
  3. You can add/remove tokens any moment
  4. Trustless set up
  5. The reward comes from the trading fee (coming soon)

Provide

  1. You can add only one coin from the list of supported coins
  2. You will not experience impermanent loss
  3. You can add tokens at any time. Removing the process usually fast but in some cases might take up to 3 days.
  4. Trusted set up
  5. The reward comes from LP fund
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Hey @andrelfpinto thank you so much for the detailed information about impermanent loss. Honestly I haven’t taken the time to really go through what you wrote because I know I will need to focus on it and really give it some time to be able to give myself the best chance of understanding. Unfortunately I am quite often in a rushed-type headspace so I just need to take a pause and go through it. Thank you for what you have written and I appreciate you doing so. I look forward to really figuring this bloody thing out! :smiley:

And hello @andrey! Boom thank you very much for the succinct information! That is absolutely perfect and answers the question indeed. I figured that by using the Provide option (which is what I’ve been using) it might not involve impermanent loss because there would only be one token and it wouldn’t be a pair of tokens constantly fluctuating between buying/selling. Great news. Just another reason I love Incognito and PRV so much. Thanks again and I will be sure to go through the LP Fund link as well to really hammer the concept home.

Thanks you two!! :smiley:

2 Likes