What is Impermanent Loss?
Impermanent Loss refers to the loss caused by the fluctuation of external market prices when the liquidity provider provides liquidity (Share/LP) to the capital pool under the operating environment of Automatic Market Making (AMM). The impermanence loss only exists under AMM algorithm, and it may disappear after the asset price recovers. However, in most cases, impermanence loss is actually eternal because asset prices cannot be restored to their original positions. Thus, it is also called differential losses. To put it simple, impermanence loss is caused by the price difference between the same asset on different platforms.
After providing liquidity (Share/LP) to the capital pool, the liquidity provider obtains part of the “shares” in the capital pool. According to the OneSwap White Paper, 60% of the transaction fee income from swap and trade generated in the Pair contract will be distributed to liquidity providers.
Let's list an example here:
1) Assume that there are 900 CET and 900 USDT in the asset pool, meanwhile, the price of 1CET=1USDT;
2) LP(Liquidity Privider) "A" has added 100 CET and 100 USDT into the pool,thus there would be 1,000 USDT and 1,000 CET in the pool in total. LP "A" owns 10% of the assets in the pool, and the value of his assets is 200 USDT.
3)Assuming that user B sold 100 CET and his order was executed in the asset pool. Then according to the CPMM( Constant Product Market Maker) rule, he would get(1000-1,000,000/1100)= 90.909 USDT. Thus there would then be 1,100 CET and 909.091 USDT in the pool. We can calculate that the price of CET at this time is 0.826 USDT.
4) Assuming that LP "A" is going to remove the liquidity at this time, since that he owns 10% of the assets in the pool, he can remove 10%*1,100 CET+ 10%*909.091 USDT in total, that is, 110CET and 90.9 USDT. The value of 110CET+90.9 USDT would be 0.826 * 110+90.9=181.76 USDT；
5) At the begining, the assets that LP "A" owns worth 200 USDT, after adding the assets into the pool, his assets become 181.76 USDT, which means his impermanent loss is 18.24 USDT.
Note: to simplify the calculation, trading fee wasn't considered during the process.
Impermanent loss would be prevalent at the begining of market making and when the market constantly goes up or goes down. As the abtaining of trading fee and the fluctuation of market price, impermanent loss would gradually disappear and users can gain profit from providing liquidity.