DeFi Lessons: Impermament Loss Explanation And Calculation

You may have heard of impermament loss since it is in the mouth of every farmer on smartBCH DeFi.

And while it is a trending term that often reproduced without an explanation, everyone makes a conclussion and understands this as losing money because prices dropped. Not exactly right as we will see in this review of a very useful tool for DeFi yield farmers.

I got to begin with the Llama on the image used to present this topic first! I simply love Llamas and find them to be really cute, also it is connected with the DeFiLlama website that gives a boost to smartBCH having added our 5 DEXs since a few months ago, and giving the TVL statistics that help Defi investors select new platforms and explore new DeFi worlds and opportunities.

Impermament loss

When we add liquidity we need holding both pairs of the pool we select. When staking we just lock our tokens in a program that gives us either fixed or variable interest, usuall the second, but we don't provide these tokens to the liquidity of the exchange.

Only when we use LPs we put our tokens in use for the exchange and get rewards in terms of APR. A pool should never be depleted as if this event occurs then we will have many problems and will not be able to withdraw until new liquidity enters.

The impermament loss is not realized loss. It only appears as a loss when we withdraw the LPs. Impermament loss means after we withdraw from the liquidity pool, we now have less value in our tokens, than what we would have if we just held them in our wallets and not provide liquidity.

So, this is not about just the price drop, even if prices go higher, we will profit less than just holding.

Making user we understand this. Impermament loss is always going to happen, unless we manage to withdraw liquidity and price of both tokens we used are the same as the time we provided liquidity.

Just saying this is a standard practice in DeFi, everyone suffers impermament loss due to the system of realocating our liquidity.

Why do we risk providing liquidity then?

DEXs give back APR in most cases in native tokens, and we expect to make more from the tokens to cover the loss of profit.

High APRs are usually found in volatile tokens. The most recommended are tokens with less volatility, since we don't buy a token for its price explosion but for the ability to make a great APR reward in exchange tokens and achieve profit.

The calculator from dailydefi.org can be used to estimate our current impermament loss and find out if our strategy is working.

In this example the impermament loss will be 5.72%.

Explanation is given and we understand exactly how impermament loss works.

The main fact one needs to understand is impermament loss is always going to happen. It will be very rare to find both prices of the assets provided as liquidity to have the same price. And in case prices of the assets are higher you have a profit from the rise of valuation, so it will not make sense to wait for lower prices to sell.

Impermament loss is mostly considered when prices drop, so at that point the loss will be even worse than when just holding the two tokens. In this case, you only lose money when you sell (realize losses).

What we need is having profit from the APR of the LP give us enough tokens to cover for the impermament loss. This will make our DeFi investment profitable.

Finally

This post contains some details on impermament loss and more can be found in this links from bybit and this one by James Bachini. I tried to explain it plain and simple in an approach I would like to have this presented, instead of all those I kept reading and listening that did not exactly understood themselves what the term impermament loss meant.

Back to smartBCH again, I am telling you that TVL (in USD) for smartBCH will explode. It is stuck at a top of $ 36 million for all December, just because the price of BCH is down, but either way it will keep increasing. Honestly, I see today no reason for BCH price to keep dropping since smartBCH keeps increasing in size. All the traders I've discussed and pointed to all the data for Bitcoin Cash with smartBCH combined, they are surprised price of BCH is still dropping and hasn't doubled yet.

It will be massive and we will witness 50% daily green candles at some point, when the smartBCH time begins, but notice that it may take a longer time than what we expected. No matter what the market will do, BCH is today the safest investment, one that will negate any kind of bear market and begin acting indepedent to the Bitcoin's price actions.

When this is over, Bitcoin Cash will be back to a better position but I'm telling you know, the market will be more mature towards it and there will be a shift from BTC towards Bitcoin Cash that will shift the balance. Even more, I fortell that time for Ethereum to reach the first place in crypto is closer. Bitcoin Cash will begin the push and together with Ethereum will end the Bitcoin BTC supremacy in market cap.