An article about the impermanent loss in Defi liquidity mining

Liquidity mining is certainly not a profitable exercise, and unlike bank savings, it is constantly subject to price fluctuations.

An article about the impermanent loss in Defi liquidity mining

Today we’ll talk about the impermanent losses often mentioned in liquidity mining, there are no complicated calculations involved in this article, so please feel free to read it. (In fact, my articles are gradually building a blockchain knowledge system for you. When you finish reading all the series of articles, you will find yourself getting started)

What is liquidity mining
First, let’s expand on the concept of “mining”. When it comes to “mining”, many people think of graphics cards, mining machines, wasted electricity, and a host of other words.

Those who understand the principles of bitcoin should know that the first miner to figure out the hash value has the right to pack the block and get the bitcoin reward, and this process is a form of mining that spells out how good or bad your equipment is. Of course now there is not only arithmetic mining, there is also hard disk mining, than whether your hard disk storage is large enough, this type of mining I collectively called “physical mining”, with the use of visible and visible equipment. And “liquidity mining” and the future “PoS proof of interest” is a kind of “virtual mining”.

Liquidity mining” as a form of “virtual mining” requires you to use your own funds in order to provide liquidity for the act of mining, in other words, “liquidity mining” is actually an abstract form of investment.

Generally speaking, the implementation of trading functions on a decentralized exchange requires a trading pool, and how a pool can ensure that everyone can trade properly requires that there is enough liquidity in that pool. For example, if we were still living in the ancient days of bartering, and you wanted to trade corn for radishes, but the people who had radishes in the market didn’t necessarily want corn, it would be hard to guarantee that the trade would be implemented. This time someone proposed to build a corn and radish can exchange the ATM machine, you can directly throw the corn in for out of the radish, there are radish people can also directly throw the radish in for out of the corn, so you can greatly solve the problem of trading. Of course, there is a problem here, how to ensure that there are enough radishes and corn in the ATM machine can give you to change it, this time it is necessary to have “volunteers” to “rent” their radishes and corn to the ATM to provide liquidity, as long as the market does not appear everyone crazy exchange corn or crazy exchange radish scene, then this ATM machine can basically ensure the normal exchange function.

The “volunteers” mentioned here are the users who provide liquidity, the “leasing” is actually the act of providing assets, and the ATM is the “smart contract” for these mining acts.

Rewards for liquidity mining
As mentioned earlier, the assets are “leased” to the “smart contract”, and since they are “leased”, there will be interest, and usually the rewards for liquidity mining are the governance tokens of the platform, for example, if you provide liquidity to Curve, then you will get crv tokens as a reward, and these tokens often come from the fees paid by the transaction users.

This model is actually a decentralized self-sufficiency spirit. In order to attract funds to provide liquidity at the beginning of the project, a high annual return rate is often given, so there is a saying of “digging the dirt dog mine” in the circle, which usually refers to this kind of high yield initial project. Of course, this high yield inevitably hides a huge risk.

Uncommon Losses
Liquidity mining is certainly not a sure thing, and unlike bank savings, it is constantly subject to price fluctuations. Let’s say you deposited 10 corn and 20 radishes (40 radishes in total) into an ATM when corn = 2 radishes, and now the market changes and corn becomes expensive, becoming one corn equal to 4 radishes, and then someone arbitrage, knowing that the corn in the ATM is still cheap or equal to the price of 2 radishes, so they frantically take radishes Go to exchange corn until the price in the ATM is also 4 radishes, at this time you then go to take their own deposit of vegetables will find that you may only take out 8 corn and 24 radishes, you may carefully take the market price a calculation of 8 corn plus 24 radishes = 58 radishes, than before 40 radishes to earn, but in fact, if you do not take the money to do mining, you put in hand, now 10 A corn plus 20 radishes = 60 radishes, you earn 2 radishes less, and the two radishes is the impermanent loss, the same reason for the price drop.

To summarize, in liquidity mining, if the price rises you will earn less than the original, if the price falls you will lose more than the original, only when the price returns to the time you deposited your assets, you have no losses, that is, when one corn equals two radishes.

Since volatility brings losses, why would anyone want to provide liquidity? The reason is that if the gains from mining are large enough to offset the impermanent losses, then your entire sale is still profitable. Take the previous case, for example, this ATM was invented by a man who grows peaches, you will be rewarded with peaches if you deposit turnip corn into the ATM, and the price of this peach is very expensive and is still rising, then overall it is still profitable to provide liquidity.

How to reduce impermanent losses
Many people may wonder since volatility brings losses, where do these losses go, in fact, there is a very important role here is the “arbitrageurs”, these people balance the price by moving assets, and your losses are earned by them.

How to reduce impermanent losses.

Choose a pool of less volatile assets, such as a stablecoin pool, and the corresponding gains might be reduced.

Choose a platform that deals with ‘arbitrageurs’, such as DODO, CoFix, which are balancing prices by means of a prophecy machine, rather than allowing arbitrageurs to balance prices, reducing impermanent losses to some extent.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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