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Generalizing Impermanent Loss on Decentralized Exchanges with Constant Function Market Makers

May 25, 2022

Abstract

Liquidity providers are essential for the function of decentralized exchanges to ensure liquiditytakers can be guaranteed a counterparty for their trades. However, liquidity providers investing inliquidity pools face many risks, the most prominent of which is impermanent loss. Currently, analysisof this metric is difficult to conduct due to different market maker algorithms, fee structures andconcentrated liquidity dynamics across the various exchanges. To this end, we provide a frameworkto generalize impermanent loss for multiple asset pools obeying any constant function market makerwith optional concentrated liquidity. We also discuss how pool fees fit into the framework, and identifythe condition for which liquidity provisioning becomes profitable when earnings from trading feesexceed impermanent loss. Finally, we demonstrate the utility and generalizability of this frameworkwith simulations in BalancerV2 and UniswapV3.

Find the full paper here: Generalizing Impermanent Loss on Decentralized Exchanges with Constant Function Market Makers

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