The Wolf Den #381 - The Math Behind Impermanent Loss
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This newsletter is sponsored by PHEMEX, the world's best crypto exchange for both spot and leverage. Sign up with the link above and get some free Bitcoin - up to $3600 worth. I really encourage you to check them out.I recently presented the idea of impermanent loss. The concept is a tricky one to grasp, which is why I wanted to revisit it with a clear example and look more closely at the math. If you are interested in yield farming, the case study below will outline why your principal is likely losing value. Remember, to be successful in farming, the only thing you need to ensure is that your rewards > losses. Below is a hypothetical pool with made-up tokens, and is a reflection of how farming works.Let’s imagine the farm uses two coins, $WOLF and $PACK. Wolf is trading at $100, and Pack is trading at $1. This means that for our liquidity pool to function, the pool needs to maintain an even value of 50:50 between these two coins.Right now, the pool has 9 Wolf coins and 900 Pack coins. You see a great opportunity to farm for yield, so you decide to contribute 1 Wolf coin and 100 Pack coins. This ensures that the pool remains even. It now totals 10 Wolf coins and 1,000 Pack coins. The pool is currently valued at $2,000. With your contribution, you now own 10% of the funds in the pool, $200.If a day passes and the coins remain the same price, you collect trading fees and you have an impermanent loss of $0. Furthermore, if a day passes and each coin rises 10%, you also have an impermanent loss of $0 and have made some gains on fees and price appreciation. This is a good thing!What happens when volatility strikes? Let’s pretend that Wolf coin shoots up to $400 a coin and Pack coin retains its value at $1. This sounds like a great scenario - neither coin has lost value and one has pulled a 4X.The 10 Wolf coins in the pool are now worth $4,000 and the 1,000 Pack coins are still worth $1,000. The pool has a new total value of $5,000. For the pool to function as designed, the pool needs to rebalance the total values, or its liquidity could be jeopardized. This is the role that market makers looking for arbitrage opportunities play, which I described in the previous newsletter.So, what happens to the pool?The pool is going to remove 50% of the Wolf coins and double the Pack coins. This would total out to 5 Wolf coins worth $2,000 and 2,000 Pack coins worth $2,000. The values of the tokens are rebalanced, but at what cost?Remember, you own 10% of this pool, so when you withdraw your liquidity tokens and cash them in, you are entitled to .5 Wolf coins and 200 Pack coins. Together this is worth $400, not bad considering your initial investment was $200, right?Wrong.Your original Wolf coin would be worth $400 and Pack coin $100, a total of $500. You just experienced an impermanent loss of $100. You "lost" $100 by farming. HODLing would have been more profitable. This hypothetical situation is just one of many ways that farmers can incur a loss and is an example where the value actually rises. When one drops, your principle is on a fast track towards $0.My goal is not to discourage you! I simply want to clarify the unadvertised risks. AMMs are made possible through incredible technology, are still finding their role, and perfecting their mechanics.Stay safe and have fun farming!In This Issue:The Math Behind Impermanent LossBitcoin Thoughts And AnalysisAltcoin ChartsJack Dorsey Leaves Twitter MicroStrategy Buys The DipThe Wolf Of All Streets Podcast Ft. Dave WeisbergerMy Recommended Platforms And ToolsIF YOU HAVE ANY ISSUE WITH THE NEWSLETTER OR YOUR SUBSCRIPTION, PLEASE CONTACT: PREMIUMSUPPORT@GETREVUE.CO
The Wolf Den #381 - The Math Behind Impermanent Loss
The Wolf Den #381 - The Math Behind…
The Wolf Den #381 - The Math Behind Impermanent Loss
This newsletter is sponsored by PHEMEX, the world's best crypto exchange for both spot and leverage. Sign up with the link above and get some free Bitcoin - up to $3600 worth. I really encourage you to check them out.I recently presented the idea of impermanent loss. The concept is a tricky one to grasp, which is why I wanted to revisit it with a clear example and look more closely at the math. If you are interested in yield farming, the case study below will outline why your principal is likely losing value. Remember, to be successful in farming, the only thing you need to ensure is that your rewards > losses. Below is a hypothetical pool with made-up tokens, and is a reflection of how farming works.Let’s imagine the farm uses two coins, $WOLF and $PACK. Wolf is trading at $100, and Pack is trading at $1. This means that for our liquidity pool to function, the pool needs to maintain an even value of 50:50 between these two coins.Right now, the pool has 9 Wolf coins and 900 Pack coins. You see a great opportunity to farm for yield, so you decide to contribute 1 Wolf coin and 100 Pack coins. This ensures that the pool remains even. It now totals 10 Wolf coins and 1,000 Pack coins. The pool is currently valued at $2,000. With your contribution, you now own 10% of the funds in the pool, $200.If a day passes and the coins remain the same price, you collect trading fees and you have an impermanent loss of $0. Furthermore, if a day passes and each coin rises 10%, you also have an impermanent loss of $0 and have made some gains on fees and price appreciation. This is a good thing!What happens when volatility strikes? Let’s pretend that Wolf coin shoots up to $400 a coin and Pack coin retains its value at $1. This sounds like a great scenario - neither coin has lost value and one has pulled a 4X.The 10 Wolf coins in the pool are now worth $4,000 and the 1,000 Pack coins are still worth $1,000. The pool has a new total value of $5,000. For the pool to function as designed, the pool needs to rebalance the total values, or its liquidity could be jeopardized. This is the role that market makers looking for arbitrage opportunities play, which I described in the previous newsletter.So, what happens to the pool?The pool is going to remove 50% of the Wolf coins and double the Pack coins. This would total out to 5 Wolf coins worth $2,000 and 2,000 Pack coins worth $2,000. The values of the tokens are rebalanced, but at what cost?Remember, you own 10% of this pool, so when you withdraw your liquidity tokens and cash them in, you are entitled to .5 Wolf coins and 200 Pack coins. Together this is worth $400, not bad considering your initial investment was $200, right?Wrong.Your original Wolf coin would be worth $400 and Pack coin $100, a total of $500. You just experienced an impermanent loss of $100. You "lost" $100 by farming. HODLing would have been more profitable. This hypothetical situation is just one of many ways that farmers can incur a loss and is an example where the value actually rises. When one drops, your principle is on a fast track towards $0.My goal is not to discourage you! I simply want to clarify the unadvertised risks. AMMs are made possible through incredible technology, are still finding their role, and perfecting their mechanics.Stay safe and have fun farming!In This Issue:The Math Behind Impermanent LossBitcoin Thoughts And AnalysisAltcoin ChartsJack Dorsey Leaves Twitter MicroStrategy Buys The DipThe Wolf Of All Streets Podcast Ft. Dave WeisbergerMy Recommended Platforms And ToolsIF YOU HAVE ANY ISSUE WITH THE NEWSLETTER OR YOUR SUBSCRIPTION, PLEASE CONTACT: PREMIUMSUPPORT@GETREVUE.CO