The Vesper View: Impermanent Loss Explained
The advent of DeFi enables crypto HODL’ers and traders to deposit their assets to various platforms that will put it to work. And for doing so, they earn passive yield on their deposit.
However, steady, passive yield is sometimes too good to be true. DeFi adventurers must be wary of impermanent loss (IL), a situation where Automated Market Makers (AMM) using protocols like Uniswap are exposed to losses on their principal due to volatility of the assets.
Understanding Impermanent Loss
On the surface, “impermanent loss” doesn’t sound that bad. “Certainly it must be better than a permanent loss, right?” one might say. The reality, however, is a bit more complicated.
The problem: If ETH appreciates in value, the user will withdraw less ETH than they started with. It’s simple supply-and-demand: In the Uniswap liquidity pool, for example, traders are swapping ETH out of the pool as it goes up in price, meaning there is now less ETH and more of the token it’s traded against (e.g., USDT, USDC, or DAI). As such, those posting liquidity similarly now have claim to less ETH (and more of the alternative) than when they started.
For example, let’s say you deposit one ETH (~$400) to a vault. Half of that is sold for USDC and plugged into the ETH-DAI market. You now have 0.5 ETH and 200 USDC. If ETH rises 20% in value, your LP is now worth 0.45645 ETH and 219 USDC. At a new price of $480 per ETH, you have ~$219 worth of ETH and 219 USDC, for $438 overall. Had you instead held your one ETH, you’d have $480. You lost $42, over half your profit, from otherwise holding. It’s an “impermanent” loss because you’re back to breakeven if the price of ETH falls back down to $400.
(More information on the mathematics of AMM.)
The best way to insulate yourself from Impermanent Loss is to understand how your deposits are deployed and ensure that there is no exposure to this risk outright.
Vesper Holding Pools: Navigating Impermanent Loss
Vesper’s launch pools inherently do not expose deposits to impermanent losses. Deposit assets in these holding pools are posted as collateral or deployed outright to generate interest. The deposits are never sold or otherwise swapped for other coins.
This standard for holding pools protects the emphasis of the pools as truly hands-off, passive, sustainable options for participants. With risk scores assigned to each pool, users have an even more comprehensive framework for choosing the strategy that corresponds best to the risk tolerance they are most comfortable with.