👁 A clear look at impermanent loss

⚫️️️️ We're continuing our series of interactive pages explaining tricky crypto terms. Today, we'll look at the concept of "impermanent loss." In this post, we'll explain what it's all about, and on a separate page, you can experience it "in practice."

⚫️️️️ First, let's review the basics. On a DEX, funds for swaps are taken from "liquidity pools." Anyone can provide their funds to a pool and earn a share of the fees the DEX charges for swaps in that pair. That is, you can become a liquidity provider so your crypto savings don't just sit there, but generate profit.

⚫️️️️ But there's a tricky part: price changes can cause "impermanent loss," where the value of the assets in the pool is lower than if they had just been "held." If the price returns to its original level, the loss disappears (hence "impermanent"), and the collected fees may exceed it anyway. But it's worth understanding how this works.

⚫️️️️ For example, let's imagine a fictional situation. TON is worth $100 (well, one can dream). A "TON / USDT" pool contains 10 Toncoins and 1000 USDT (meaning the two amounts are equal, a 50/50 ratio). And a holder named John contributed 10% of this pool (that is, 1 Toncoin and 100 USDT). His contributed assets are worth a total of $200.

⚫️️️ Then, TON's price increases to $400 (if you're going to dream, dream big). Everyone rushes to exchange USDT for TON, and the pool automatically rebalances to the new exchange rate during swaps. Now it contains 5 TON and 2000 USDT, so it's still 50/50. John owns 10% of the pool. If he withdraws his share now, he will receive 0.5 Toncoin and 200 dollars. In total, this is now $400.

⚫️️️ In this scenario, John has generally profited. But if his 1 Toncoin and 100 dollars had "just been held" outside the pool, they would be worth $500 together. It turns out he could have earned even more, and the difference he missed out on is his "impermanent loss." TON could later return to $100, and the effect of the loss would disappear, but it could also rise even higher.

⚫️️️ In these calculations, we haven't considered John's earnings from fees at all. This depends on how many swaps people make using the pool. It turns out that profitable pools are those with as many trades as possible, and where the token prices change as little as possible.

💡 We've explained it in theory. And now on our new page, you can give a name to a fictional token, move the price sliders, and see impermanent loss "in practice." This page is simplified (it doesn't account for profits such as fees and bonuses, and the second token is pegged to USD), but it should convey the essence.

@thedailyton