SECURITY-UST APY doesn't make sense

Hi,

I’ve pondered to post this please explain to me how does the ~40% APY make sense when the impermanent loss will obviously be bigger than that of the gains. I am talking about

mGOOGL-UST LP 44%
mNFLX-UST LP 41%
etc

Is there something that I am missing out?

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I am ab it confused about the “impermanent loss” Can you clarify? For example, I do not believe Google stock will jump by a massive percentage over the next 12 months, or drop much. But providing liquidity to mGOOGL-UST will reward approx. 44%, rewards can be cashed out daily, in case there is no trust in the MIR value. If mGOOGL itself drops significantly, it gets rebalanced. The only risk you are taking is GOOGL jumping > 200% or something like that where the 44% return is less attractive. Am I missing any other risks or wrong about my understanding of the setup?

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Please have a read below sounds like you not fully grasping impermanent loss. This guide is one of the better write ups i’ve found

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@Papi Thank you. This was helpful to define terminology to my intuitive understanding and see the way impermanent loss is calculated. So what makes you think the impermanent loss for mGOOGL-UST LP and mNFLX-UST LP would be near or even greater than -40%? As I mentioned, I don’t believe GOOGL is likely to jump 2x, let alone the 5x that ETH did in the article you linked, thereby inducing the permanent loss curve they show. I think it may not be hard to plot the GOOGL data and curve fit the impermanent loss. It may actually be much lower than -40%, perhaps -10%? But in the case of AMC, I saw the impermanent loss values from AMC $5 to current price levels. Thoughts?

I think you still might be confused. Basically think of it like this, when you LP assets you still have exposure to the underlying assets, with impermanent loss you have exposure to the underlying asset + impermanent loss, whether your coins go up or down you will still have impermanent loss . But impermanent loss is only around 5% for every 100% increase/decrease from the value when you originally lp’d the asset.

So in the example of mGOOGL-UST, Google goes down 20%, you will loose 20% + 1 - 2% impermanent loss . If Google goes up 20% , you will gain 20% minus 1-2 % impermanent loss.

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This is a really great point.

A great video on impermanent loss here too.

I do think, however, that the nature of impermanent loss relies on some assumptions that may or may not apply to each investor / participant.

Comparing total upside in a buy and hold strategy to the total upside in a liquidity provisioning strategy is an apples to oranges comparison. The investors risk tolerance and strategy determines which concept they embrace.

So it seems there are three states:

  1. Asset trades sideways
  2. Asset gains value
  3. Asset losses value

Within the context of impermanent loss, we are interested in 2 and 3. Why? Because arbitrage is the mechanism through which liquidity pools remain in balance. This means that some of the value that is created by an arbitrage opportunity is ported out of the pool - this goes in arbitrageurs pockets. However another portion of this is captured by the pool participants in the form of fees.

The result is that the volatile asset within the pool reaches parity with the larger outside market…and now the pool pricing remains accurate. Arbitrageurs receive risk free income and liquidity providers receive fees and are saddled with the potential of “impermanent loss.”

The last part is super important because impermanent becomes only permanent when a liquidity provider exits the pool. SO if your hustle is generating fees as cash flow - you might never transition from impermanent to permanent loss. All of that is to say - providing liquidity is a strategy to generate some sort of cash flow, it is not a trading strategy in and of itself (although it could be part of a larger trading strategy if you transitioned all cash flows generated to an asset that could give you the volatility you are looking for).

In that sense you are correct, if your goal is to buy low and sell high, and you want to maximize that outcome, it doesn’t make sense to participate in liquidity pools. That’s the assumption that is made with impermanent loss. The counter to that is realized cash flow is more valuable to some investors - depends on strategy, risk tolerance, etc - than speculative value.

Arbitrage, provisioning liquidity, and trading are all separate strategies for market participation - and while they absolutely can be intertwined in a larger strategy - the basic incentive structures for liquidity pools assume they are separate. All of those strategies have distinct and commensurate levels of risk associated - if you buy and hold your investment it can go to zero or infinity, if you provide liquidity you generate fees, your risk is lessened, therefore you cannot benefit from the total upside that someone who is buying and holding will achieve.

It’s definitely an interesting topic.

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@Papi and @still Thank you for the great discussion. Both links were very helpful. My confusion was on determining the impermanent loss. @Papi you are quoting 5% for every 100% change in price (up or down). I wonder how you got that number. The link shows the impermanent loss for ETHUSD and it roughly follows the 5% per 100% estimate you provided. I would imagine that this depends on trading fees and other parameters. Any thoughts on these? I can imagine different platforms, therefore, will have different impermanent loss for the same type of asset that liquidity is provided for (Uniswap, Bankor, etc.).

@still I like the breakdown of investment mechanisms, this would be a useful topic of conversation for investors who are looking at the different options.

You have remember you are using a stable coin so the loss from my research can be seen at sqrt (1- % mAsset change). For example, on 100 mSPY drops 10% the impermanent loss or your balance would be (100*((sqrt(1-.1)) = $94.8. this assumes a vacuum and doesn’t calculate the slippage and arb loss on each rebalance which can be more than the APY and asset underlying loss over time. Adding 20 percent from ANC on top of a delta neutral mSPY long/short pools really starts to make sense

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I reviewed some of the background on impermanent loss for XYK AMMs, like Uniswap, Aave. I am less familiar with others at the moment, like Bancor and some one-sided liquidity providers. The Binance chain one, for example, has no permanent loss,I suspect it is not an XYK model, and if it is, perhaps Binance just pours into the liquidity pool to match the delta in a single asset price.

One of many examples Impermanent Loss Explained With Examples & Math - The Chain Bulletin and even simulated numbers which is what I wanted to do Decentralized Liquidity Pools: A Deep Dive With FinNexus Options | Alexandria

Show the impermanent loss curve is largely independent of the fees or specific value for the AMM. The fees can be adjusted to fully eliminate the impermanent loss if the fee is less than or equal to the input value ratio to the overall pool value, so pools with large amounts can realistically offer that. The article above cautions that, in reality, there is a lot of noise in the system, with providers and arbitrageurs behaving differently, so the IL can vary from provider to provider, and as @bitn8 pointed out above, price slippage and other factors can have additional effects.

In the basic XYK formulation, the IL curve formula simply calculates the ratio (as %) of the total value in the pool versus not in the pool as a function of the price of one of the assets (presumably the one whose value is changing while the other is a stablecoin or unchanged). So for a 100% price change, the IL is approx. 5.7% on Uniswap with 0.3% fees, as @Papi stated above.

Really easy to see in the simulation for ETH/USDCS over the months in 2020, as ETH price started surging in the latter part of the year, the IL increased significantly. Source is the CMC link above

Another useful link is Understanding the XYK model of pooled liquidity | by Ryan Tian | Phoenix Finance | Medium

And a list of liquidity pools with IL estimates (not sure how it is calculated) Current Crypto DeFi Yield Farming Rankings | CoinMarketCap

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impermant loss is an oppurtunity cost and nothing more… Ask yourself do I fully believe this asset and be willing to hold it… well then dont LP. but if your happy with (esp mirror stable-asset) pairs, 50% of what the gain would be had you held all asset and your mir rewards. simple as that. Lots of people really place too much of an importance in IL. Most of the time they wouldnt even be buying the asset in the first place

also @Papi the problem with that guide is that it makes it seem as if you actually lost instead of winning. thats where the confusion comes in esp with the naming convention of Impermant Loss. Your not losing vs winning. your losing some of your gains vs all of your gains had you held the single asset. (in the scenario where asset prices increase or one stays the same). what if link tanked?? well you would have been happy in the Link/eth LP cause IL would have lost you less

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This impermanent loss calculator might be helpful to you.

Based on today’s price, GOOGL ($2504 USD) would have to drop down to $250 or go up to $25,000 USD in order to create an impermanent loss of 44%. If you believe that is likely to happen, you might be better off not providing liquidity. If you believe it is unlikely to happen, then you can see why providing liquidity can be profitable.

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