Half of Uniswap v3 money donors lose money
Recent research shows that impermanent losses have become a growing problem for liquidity providers on Uniswap v3. A November 17 report from Topaz Blue and the Bancor Protocol found that 49.5% of liquidity providers on Uniswap v3 experienced negative feedback on Impermanent Losses (IL). Uniswap is the world’s most famous decentralized exchange (DEX). Consistently, over $ 70 billion in trading volume is executed on the Ethereum-based exchange. Nonetheless, customers who donate cash in the hope of earning fee rewards may not reap the profits they hoped for.
Whenever a trade is executed on Uniswap, Liquidity Providers (LPs) receive a fee proportional to the amount of liquidity they have provided. These fees are usually set at 0.3% but can be as low as 0.05% for stable assets, and as high as 1% for more exotic pairs.
Uniswap v3, the latest and most sophisticated version of the popular decentralized exchange, is used by tens of thousands of crypto traders. While some use the Automated Market Maker (AMM) to trade between tokens, for example ETH to USDT, others provide liquidity by allocating tokens to a pool of assets controlled by a smart contract.
Over time, these fees can generate significant profits for LPs – at least in theory. In practice, however, the income generated in the form of fees is often outweighed by the dollar losses caused by so-called impermanent losses (IL).
“Our main conclusion is that on the whole, and for almost all the pools analyzed, the impermanent losses exceed the charges collected during this period”, conclude its authors. “We have collected evidence that suggests inexperienced retail users and sophisticated professionals find it difficult to make a profit under this model.”
Without getting too technical, IL is the result of fluctuations in the underlying value of the assets being traded. Crypto assets can be volatile and when a token drops in price, this leaves liquidity providers with less, in dollar terms, than they initially did. The new study has shown how impermanent losses can erode profits.
Providing liquidity is complicated
The previous version of Uniswap, known as v2, allowed users to add a 50-50 token weight (eg $ 1,000 ETH and $ 1,000 USDT) with just a few clicks. While Uniswap v2 is still available, accounting for about a third of the monthly v3 volume, it has been replaced by the more complex Uniswap v3.
Despite having more bells and whistles, however – including the ability to provide liquidity within tightly controlled price brackets – v3 failed to protect LPs from fleeting losses. In fact, the complexity of v3 can make the problem worse.
Although Uniswap v3 generates more fees than any other challenge protocol, over 80% of the pools analyzed in the study saw losing LPs due to temporary loss. Additionally, the study found no statistical evidence that users who adjusted their positions more frequently performed better than those who did not, suggesting that v3’s dynamic charge settings may actually be worse for LPs than static v2.
DEX designers grapple with impermanent loss
DEX architects such as Uniswap have long struggled with the problem of how to incentivize the provision of liquidity with users penalized by IL. Tellingly, the Uniswap Impermanent Loss Study was commissioned by Bancor, the developers of an alternative MA that promises “100% impermanent loss protection” by allowing users to provide unilateral liquidity. Instead of pooling two tokens in equal parts, in other words, it allows them to provide only one, like a stablecoin whose price will hardly fluctuate.
While solutions such as Bancor offer LPs greater protection, the bulk of all DEX volume remains focused on Uniswap. Despite all its faults, it is still the biggest MA in the industry. Greater awareness of Uniswap’s fleeting losses issue is unlikely to trigger a massive cash drain. However, this will at least make LPs more aware of the risks of providing liquidity in pursuit of rewards.
Summary of the news:
- Half of Uniswap v3 money donors lose money
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