Zethyr impermanent loss explained

October 05 2020

Impermanent loss: a temporary (unrealised) loss of funds you may suffer from providing liquidity to a liquidity pool. It is the difference between holding an asset versus providing liquidity for that asset in a liquidity pool.

The loss is impermanent as long as you do not withdraw your liquidity from the liquidity pool. The loss will be permanent (realised) if you withdraw your liquidity from the liquidity pool.

 

Example

Assume a scenario in which:

1 USDT = 1 USD

1 TRX = 0.025 USD

 

For simplicity, we assume that the liquidity pool is currently empty and you are the first one to provide liquidity.

To provide liquidity to the pool, you provide:

10,000 USDT = 10,000 USD

400,000 TRX = 10,000 USD

 

If the price of TRX in the market goes up to 0.03 USD, an arbitrager will come in to buy TRX from the liquidity pool and sell in the market until the price of TRX in the liquidity pool goes up to 0.03 USD.

Since the Automated Liquidity Maker formula is x * y = k

In this case, x = 10,000 USDT and y = 400,000 TRX

Therefore k = 10,000 * 400,000 = 4,000,000,000

For TRX price in the pool to go up to 0.03 USD, the pool must have 365,148.37 TRX and 10,954.45 USDT inside.

So as the original liquidity provider, your asset in the pool is now worth.

365,148.37TRX * 0.03 + 10,954.45 USDT = 21,908.90 USD

If you have not provided the liquidity, you would have had

400,000 TRX * 0.03 + 10,000 USDT =  22,000 USD

which is $91.1 more than your asset in the liquidity pool. $91.1 is the impermanent loss.

 

Is this all to impermanent loss?

Stay tuned for part 2 of impermanent loss.