Bancor’s single-sided liquidity pools are great. No math, no maintenance, no middlemen. At Bancor, you just sit back and collect fees. It’s DeFi made simple.
Korpi expressed: Do long-term liquidity providers (LPs) to AMMs earn passive income? What is their ROI when the impact of impermanent loss (IL) is included? I compared LPing on Uniswap and Bancor to check if IL-protection from Bancor is a useful feature for LPs.
Do long-term liquidity providers (LPs) to AMMs earn passive income? What is their ROI when the impact of impermanent loss (IL) is included? I compared LPing on Uniswap and Bancor to check if IL-protection from Bancor is a useful feature for LPs.
LPing involves investors lending their idle assets to an AMM in anticipation of passive returns from trading fees. Although trading fees do generate a revenue stream for LPs, it’s not always guaranteed passive income. It would be, were it not for the infamous impermanent loss.
IL is the difference in value between holding tokens in an AMM liquidity pool and holding them in a wallet. This difference can be either equal to 0 (no IL) or negative (IL). IL can’t be avoided and it results from the AMM design.
IL is dependent on the price ratio between two tokens in the pool. The bigger the divergence between the current price ratio and the initial price ratio, the greater the IL. However, if the price ratio returns to the initial state, IL disappears. That’s why it’s “impermanent”.
There are a few ways LPs can mitigate IL by taking a more active approach to LPing, however, none of them guarantee they will not suffer from IL and eventually incur a net loss from LPing. I described a few mitigation strategies in my thread on IL:
IL is pretty painful in LPs with volatile assets and stablecoins. We come to the 1st (obvious) tip: 1: To minimise IL, add to LP positively correlated assets. ETH and WBTC are perfect example. They are highly correlated so low risk of IL.
When using AMMs, traders pay a fee which goes to liquidity providers. It’s a source of passive income which can mitigate IL or even produce net surplus. How much fees you earn depends on trading volume. The higher the volume, the more fees for liquidity providers.
Buy you have to share the fees with other liquidity providers. So your passive income from fees depends also on total liquidity in LP. The lower total liquidity is, the higher share of LP you own and the higher fees you collect. What matters is volume to liquidity ratio (V/L).
The higher V/L, the more fees you earn. E.g.: For daily V/L of 1 and 0.3% swap fee, your 1$ of liquidity earns V/L*0.3%=0.003$ daily, i.e. 1.095$ annualized (109.5% APY). For V/L = 2, your LP APY=2*0.003$*365=219%. Second tip: 2: To offset IL, look for LPs with high V/L.
