Impermanent loss
Last updated
Last updated
Dimple Protocol decreases your impermanent loss rates by constantly rebalancing Vault position and assets in the narrow active price range of Uniswap v3 to earn enough trading fee income to offset the impermanent loss. Sometimes strategy will rebalance its position in one or another asset to completely get rid of impermanent loss and 100% protect your capital
Impermanent loss is a loss that funds are exposed to when they are in a liquidity pool. This loss typically occurs when the ratio of the tokens in the liquidity pool becomes uneven. Although, the impermanent loss isn’t realized until the tokens are withdrawn from the liquidity pool. This loss is typically calculated by comparing the value of your tokens in the liquidity pool versus the value of simply holding them. Since stablecoins have price stability, liquidity pools that utilize stablecoins can be less exposed to impermanent loss.
Impermanent loss typically affects liquidity pools that are meant to have an equal ratio of tokens, 50/50. In the USDC/ETH liquidity pool the liquidity providers need to provide equal portions of USDC and ETH into the pool. They are then entitled to withdraw equal portions of the pool. When users trade using a liquidity pool, which happens on decentralized exchanges, the ratio will change depending on how many tokens are in each pool, which will affect the price of those tokens.
Let’s say a liquidity provider adds 1 ETH and 100 USDC to the liquidity pool, this is for an equal value of both tokens. The dollar amount of their deposit is $200 because their ETH and USDC are both worth $100 each. Currently, there is 10 ETH and 1,000 USDC in the liquidity pool, a 50/50 ratio, which gives the liquidity provider a 10% share of the pool. They will receive LP tokens that they can use to redeem their 10% share of the pool at any time.
Since the price of tokens relies on the ratios of their liquidity pools their prices can separate from the prices on other exchanges. If the price of ETH increases by 100%, now worth $200 per ETH, the liquidity pool would have changed to 7.071 ETH and 1,414.21 USDC. This is because the ratio of the pool has changed, it is no longer 50/50, which affected the price of ETH.
Since the liquidity provider has a 10% share of the liquidity pool, they can withdraw 0.7071 ETH and 141 USDC, which equals $282. However, if the liquidity provider simply held their 1 ETH and 100 USDC, they would be worth $300. The difference between the two, $18, is the amount of impermanent loss the liquidity provider experienced. A greater change in the ratio of the pool will result in a larger amount of impermanent loss.
The amount of impermanent loss can also be impacted by the tokens in the liquidity pool as well as the number of liquidity providers in the pool. Since the above examples use an ETH/USDC liquidity pool, ETH has a stable asset to swap against. If the liquidity pool were to be ETH/LINK then the risk of impermanent loss could be higher as both tokens have the potential to be volatile. Liquidity pools can also be made up of purely stablecoins, like DAI and USDC. This significantly reduces the risk of impermanent loss because stablecoins have almost no volatility, which will allow the pool to remain extremely stable.
Below is a graph that shows how price can impact the amount of impermanent loss a liquidity provider will experience. When a token increases by 500% in price, you can see that the liquidity provider will incur an impermanent loss of approximately 25%. This is 25% less than the value of the tokens if they were simply held.
Since decentralized exchanges use equations to calculate how to adjust the values of tokens when the ratio changes, you can instead use an impermanent loss calculator to easily calculate potential losses. Below is an example of an impermanent loss calculator that can be found at
In this example, Token A is $100 and Token B is $1, with a total starting value of $1000 between the two tokens — this is set automatically by the calculator. In the “future prices” section, the value of Token A, has increased to $200 while Token B, has remained at $1.
Since the value of Token A & B being held would be $1,500 compared to them being in a liquidity pool, $1,414.21, this would result in an impermanent loss of $85.79.
This uses an example of $500 for both Token A and B. To calculate using your own amount you could multiply or divide any of the given values. If you were using $2000 of both tokens, which is double the example, your impermanent loss would be $171.58.
Below is another example of an impermanent loss calculator that can be found at decentyields.com/impermanent-loss-calculator. Here you can manually set your deposit amount as well as the ratio of the pool, and the pool weight.
In this example, the price of ETH increases 100% while Tether remains stable. Below you can see that the profit on a deposit of $4,000 is $1,656, the Pool P/L. However, the impermanent loss is 5.7% which results in a loss of $344. This can be calculated by subtracting the Pool Value from the Hold Value, $6,000 — $5,656 = $344.
However, it can only calculate from the current value of a token. If you bought the token at a lower or higher price than it is currently, it would not allow you to change that. If you require as much data as possible, you may need to utilize multiple calculators as there currently isn’t a calculator that provides every necessary function and data point.
