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Some thoughts on Impermanent Loss (IL) and APY
TLDR: it is my opinion that current APY for most projects more than compensate for IL
TLDR: it is my opinion that current APY for most projects more than compensate for IL
An asset pair has a certain annualised volatility
At any given holding period the volatility can be rescaled using
Annual_Vol * sqrt(d/365)
Where d is number of holding days
And it looks like this for an asset with 400% annualised vol
At any given holding period the volatility can be rescaled using
Annual_Vol * sqrt(d/365)
Where d is number of holding days
And it looks like this for an asset with 400% annualised vol
If you know the volatility of a random variable and assume a normal distribution (I know prices are not but does not change things significantly), you can estimate it's max move at a certain confidence interval
And this is a multiple of the vol
And it looks like this
And this is a multiple of the vol
And it looks like this
Finally you can calculate expected Impermanent Loss if you know the ratio of the price of 2 assets
divergence_loss = 2 * sqrt(price_ratio) / (1+price_ratio) - 1
see for example https://pintail.medium.com/uniswap-a-good-deal-for-liquidity-providers-104c0b6816f2
divergence_loss = 2 * sqrt(price_ratio) / (1+price_ratio) - 1
see for example https://pintail.medium.com/uniswap-a-good-deal-for-liquidity-providers-104c0b6816f2
So if you assume:
- a volatility
- a confidence
For example:
- 400%
- 99%
You can get a line that tells you the IL for any given holding time that would be true in 99% of possible scenarios
And it looks like this
- a volatility
- a confidence
For example:
- 400%
- 99%
You can get a line that tells you the IL for any given holding time that would be true in 99% of possible scenarios
And it looks like this
Finally, given a possible IL you can calculate what would be the APY that would make you whole
So with this APY and if the vol is lower than assumed you have at least 99% of probability of not losing money. And this can be calculated for every possible holding time
So with this APY and if the vol is lower than assumed you have at least 99% of probability of not losing money. And this can be calculated for every possible holding time
So even a token that has a vol against ETH of 400% (which basically means it can double in 4 days...) would require sub 200% if LP for at least 36 days
This does no include the transaction fees that accrue to the LP which must be very high for a token with such a high vol
This does no include the transaction fees that accrue to the LP which must be very high for a token with such a high vol
