As the price of ETH rose in recent weeks, users providing liquidity to some of the ecosystem’s largest AMM pools saw significant impermanent loss on their staked liquidity.
Impermanent loss occurs as a result of price divergence between a pool’s underlying tokens. In many of DeFi’s largest AMM pools, which consist of an ERC20 token paired with ETH, the sky-rocketing price of ETH led to greater divergence and therefore heavier losses.
You can see the effect across numerous pools in this impermanent loss calculator showing LP returns on Uniswap pools — as ETH moons, LPs get rekt.
USDT/ETH LP returns:
YFI/ETH LP returns:
However, there are some LPs that have faired well in pools and where impermanent loss has been minimal:
wNXM/ETH LP returns
The fact that some pools have lost significant value from impermanent loss, while others have only been minimally affected by IL and are very profitable is key to understanding Bancor v2.1.
Bancor v2.1 effectively bundles and diversifies IL risk across a wide array of pools (currently 60 whitelisted pools). While some pools have greater divergence and create a higher cost of IL compensation, other pools have less divergence and earn more fees for the protocol. When fees earned by protocol-invested BNT exceed the cost of IL protection, the protocol profits.
In this way, v2.1 shifts IL from something that occurs in a single pool to a risk spread across a network of pools in the Bancor protocol. BNT holders, who take on this risk, earn fees for doing so, while allowing for AMM liquidity provision to be more deterministic for themselves and other LPs.
That’s it. Until next time, #AlwaysUseProtection frens.
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To track network stats, go to bancor.network & Dune protection data.