Impermanent Loss: Losses can be non permanent?
When it comes to liquidity pool (LP) providing, it is critically important to fully understand how impermanent loss can significantly affect your investment. Impermanent losses refer to the situation where you might lose money while engaging in LP providing; this occurs because you are essentially buying a share in a liquidity pool rather than receiving a one-time payout. Interestingly, these losses can be impermanent if the liquidity pool sees growth again, which is a common outcome in various market conditions. Most of the time, people discuss how impermanent losses can transform into permanent ones. This situation mainly occurs when you decide to cut your losses with a particular pool or when the pool you have invested in has become outdated and lacks sufficient trading volume.
LP providers typically earn fees, and many platforms also offer rewards for supplying liquidity in order to help offset these potential permanent losses. Therefore, it is always wise to conduct thorough research on the underlying asset before investing, particularly to avoid risks such as rug pulls, where one individual provides a significant amount of liquidity with the hope that others will enter the market. The individual may then remove the liquidity from that pool, rendering the associated token untradable, as most coins only have one liquidity pool. Additionally, it is crucial to ensure that a significant portion of the liquidity from the original launch was burned. As an investor in liquidity pools, this lack of due diligence could lead to substantial financial losses, especially if the developers decide to pull the liquidity, which can trigger a sell-off as other investors may fear that the project is coming to an end. This situation results in either trading out of range or facing massive financial losses.
There is also an opposite situation that can occur where the coin could potentially go up significantly in price, leading to considerable changes in your investment landscape. In this scenario, you would either stand to make money as it trades within your designated range, allowing you to collect a percentage of the overall trading volume generated by the trades, or it may ultimately result in your owning a full 100% of one side of the trading pair. This situation would then require you to reset your range to accommodate for the new dynamics, which could involve paying excess fees that may impact your overall profitability. Therefore, it’s crucial and essential to conduct thorough research and exercise due diligence in all aspects of your investment strategies to mitigate potential risks and maximize rewards.
