Entering liquidity pools can cause loss of upside when one side of a pair goes up, called impermanent loss. I was reading binance’s resource on impermanent loss which states: “Impermanent loss happens no matter which direction the price changes.”
This sounds like it means if e.g. you had entered an LP between a stable and ETH and ETH’s price drops, you’d lose more (not accounting for farming rewards) than if you simply held the ETH and stable.
This didn’t make sense to me since LPs seem to basically just average your holdings of each. I made an example to see for myself (forgive my scratch math, hope it’s clear enough):
Your initial position, 10% of pool:
1500 DAI 150 ETH |
10$ price of ETH |
Total LP: 15000 DAI 1500 ETH
15000 + 1500 = 16500 |
10x + 1x = 16500 |
x= 1500 |
Price of ETH changes to 5$ |
5x + 1x = 16500 |
New pool amounts |
ETH = 2750 |
DAI = 2750 x 5 = 13750
Your position if you entered LP:
275 ETH and 1375 DAI |
1375 x 2 = 2750$
Your position if you held/stayed out of LP:
1500 + 150×5 = 1500 + 750 = 2250$
This seems to contradict binance’s claim, LP is basically hedging from ETH downside. Is my math or understanding wrong? Would be great if anyone can confirm.
EDIT: my math was very wrong. My ape brain did x + y = k instead of xy = k. The new math works out with LP lower as expected.