Impermanent Loss
Important articles to understand the risk of liquidity provision in the Convectium Vaults and Uniswap v3
Last updated
Important articles to understand the risk of liquidity provision in the Convectium Vaults and Uniswap v3
Last updated
When you engage in liquidity provision within Vaults or Uniswap v3 Pools, you may encounter impermanent losses. Impermanent losses should not be mistaken for actual losses incurred by liquidity providers in a DeFi protocol. Instead, they represent the opportunity cost when compared to simply buying and holding the same asset or the risk of receiving less value when closing the position.
Convectium's innovative protocol is designed to significantly reduce impermanent loss rates. This is achieved by actively rebalancing the Vault position and assets within the narrow active price range of Uniswap v3. By doing so, Convectium generates substantial trading fee income, which effectively offsets impermanent losses. In some instances, our strategies will strategically rebalance their position in specific assets to completely eliminate impermanent loss, providing you with 100% capital protection.
We've compiled a selection of essential articles that delve into the concept of impermanent loss and provide guidance on how to calculate it for your positions within the Convectium Protocol.
Impermanent loss refers to the potential loss that funds may encounter while participating in a liquidity pool. This type of loss typically arises when the balance of tokens within the liquidity pool becomes uneven. It's important to note that impermanent loss remains unrealized until the tokens are withdrawn from the liquidity pool. This loss is commonly assessed by comparing the value of your tokens within the liquidity pool to the value of holding those tokens separately. Notably, liquidity pools incorporating stablecoins, which exhibit price stability, often exhibit lower susceptibility to impermanent loss.
Impermanent loss primarily affects liquidity pools designed to maintain an equal token ratio, often set at 50/50. For instance, in the USDC/ETH liquidity pool, providers are required to contribute equal amounts of USDC and ETH. Consequently, they gain the right to withdraw an equivalent share of the pool. When users engage in trades through a liquidity pool, typically on decentralized exchanges, the token ratios can shift based on the tokens' supply, influencing their prices.
Let's illustrate this concept with an example: Suppose a liquidity provider deposits 1 ETH and 100 USDC into the pool, ensuring an equal value of both tokens, totaling $200 since both ETH and USDC are worth $100 each. Currently, the liquidity pool contains 10 ETH and 1,000 USDC, maintaining a 50/50 ratio. This grants the liquidity provider a 10% stake in the pool, for which they receive LP tokens. These tokens represent their 10% share of the pool, which they can redeem at any time.
Now, if the price of ETH surges by 100%, reaching $200 per ETH, the liquidity pool's composition changes to 7.071 ETH and 1,414.21 USDC. This shift results from the altered pool ratio, which is no longer 50/50 and subsequently impacts the price of ETH.
Given the liquidity provider's 10% share of the pool, they can withdraw 0.7071 ETH and 141 USDC, totaling $282. However, if the provider had simply held their original 1 ETH and 100 USDC, they would now be worth $300. The disparity between the two, which amounts to $18, represents the impermanent loss experienced by the liquidity provider. A more substantial shift in the pool's ratio would lead to a greater impermanent loss.
The extent of impermanent loss can also depend on the tokens in the liquidity pool and the number of liquidity providers. In the provided ETH/USDC example, ETH acts as a stable asset for swapping. However, in a scenario like ETH/LINK, where both tokens exhibit higher volatility, the risk of impermanent loss increases. Conversely, liquidity pools composed entirely of stablecoins like DAI and USDC carry minimal volatility risk, maintaining greater stability.
The graph below illustrates how price fluctuations can impact the impermanent loss experienced by a liquidity provider. As a token's price increases by 500%, the provider may incur an impermanent loss of approximately 25%, representing a 25% reduction in the token value compared to simply holding them.
Since decentralized exchanges use equations to calculate how to adjust the values of tokens when the ratio changes, you can instead use an impermanent loss calculator to easily calculate potential losses. Below is an example of an impermanent loss calculator that can be found at
In this example, Token A is $100 and Token B is $1, with a total starting value of $1000 between the two tokens — this is set automatically by the calculator. In the “future prices” section, the value of Token A, has increased to $200 while Token B, has remained at $1.
Since the value of Token A & B being held would be $1,500 compared to them being in a liquidity pool, $1,414.21, this would result in an impermanent loss of $85.79.
This uses an example of $500 for both Token A and B. To calculate using your own amount you could multiply or divide any of the given values. If you were using $2000 of both tokens, which is double the example, your impermanent loss would be $171.58.
Below is another example of an impermanent loss calculator that can be found at decentyields.com/impermanent-loss-calculator. Here you can manually set your deposit amount as well as the ratio of the pool, and the pool weight.
In this example, the price of ETH increases 100% while Tether remains stable. Below you can see that the profit on a deposit of $4,000 is $1,656, the Pool P/L. However, the impermanent loss is 5.7% which results in a loss of $344. This can be calculated by subtracting the Pool Value from the Hold Value, $6,000 — $5,656 = $344.
However, it can only calculate from the current value of a token. If you bought the token at a lower or higher price than it is currently, it would not allow you to change that. If you require as much data as possible, you may need to utilize multiple calculators as there currently isn’t a calculator that provides every necessary function and data point.
