Scared of Impermanent Loss?
Canary Exchange is launching a series of educational easy reading articles to increase awareness around DeFi in line with our mission to change the world by helping people take control of their financial well-being. One of the halloween stories in DeFi is an impermanent loss notion. Well, we thought it is a good timing!
If you are interested in DeFi you’ve probably heard these two words a lot. Impermanent Loss (IL) is a term used to describe the situation when the current total value of the liquidity pair you provided is less than what you would have if you just hold them in your wallet.
Wow, wow.. not so fast! Liquidity pair?
The way DEXes work assumes that users provide liquidity into the pools. Liquidity is usually provided in a pair of tokens.
Say AVAX and CNR — together they make a AVAX-CNR pool. Anyone who needs to swap CNR for AVAX or AVAX for CNR will be using this pool even though they may not know it — DEX will give them funds from this pool.
Liquidity is provided in pairs and the ratio is based on the current market price. Say 100 CNR = 1 AVAX. The pair needs to be 50%/50% in terms of value. Thus if you have 1000 CNR you need to add 10 AVAX to provide liquidity = 1000 CNR + 10 AVAX.
If someone swaps 1 AVAX for CNR in this pool, this pool will have 900 CNR + 11 AVAX. So if you withdraw your liquidity now you will own 11 AVAX and 900 CNR instead of 10 and 1000 initially.
Depending on USD value of each token you may or may not benefit from owning 11 AVAX and 900 CNR comparing to just holding 10 AVAX and 1000 CNR in your wallet.
If USD value of 10 AVAX + 1000 CNR is more than 11 AVAX + 900 CNR then this difference is called IL. But in our case when we have withdrawn the tokens it is permanent. Until you withdraw the loss is impermanent because someone else will come and swap CNR for AVAX and the balance will move back closer to 10 AVAX + 1000 CNR so you do not have IL anymore.
If you want to be less affected by IL …
If you want to be less affected by IL you can choose a pair of tokens which you believe has notable correlation, i.e. there is a high chance that if one token grows the other also will grow and vice versa. In this case there will be more or less equal volume of swaps between both tokens thus the balance will be always close to that which you provided in the beginning.
We should not forget that liquidity providers earn high rewards for providing liquidity which long term often outweigh any potential IL.
For example our CNR-AVAX pool which can be considered as high correlation pool earns fabulous 150% APY (disclaimer — APY rates may change depending on the saturation of the pool). Once you provide liquidity you get liquidity tokens in exchange — you need to stake them to earn high APYs — this is called farming. If you wish to withdraw liquidity — you need to un-stake liquidity tokens and then withdraw them.
If you want to be unaffected by IL at all you can choose pools with the stable coin pairs such as USDT.e — USDC.e because it does not matter if you have more USDT.e or USDC.e in the end.
We have such pool at Canary with insane for stable coins 60% APY — tell this to your local bank manager!
We at Canary are happy to offer our providers a variety of pools with different combinations of tokens and lucrative APYs.
Please make sure you visit our farms if you have not done so and let us know any questions in our telegram channel.
