Impermanent loss explained: How is impermanent loss calculated on Pancakeswap, Uniswap and Sushiswap

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PancakeSwap Farms – UniSwap / SushiSwap Pool; impermanent loss explained: How is impermanent loss calculated

If you are providing liquidity to the Pancakeswap, Uniswap, Sushiswap, Binance or any other centralize or decentralize network to make some passive income you need to watch this. Sometime providing liquidity will cost more than then making any income. This term is called impermanent loss. it’s is very important for you to understand how does liquidity pool impermanent loss calculated. and what are the best options to earn passive income while avoiding the impermanent loss.

I have been providing the liquidity to the pancakeswap farm for various pools. The most popular pool in the pancakeswap in terms of high rate and stabilized pair I find it is cake-bnb token coin. I already made a video, explaining how to stake cake-bnb liquidity pool on pancakeswap and earn some passive income, if you are interested, you can find that video on my channel. The current market is really volatile and I was also experimenting loss of revenue on the liquidity pool as well. This is why I choose Cake-BNB as an example to show how this Liquidity Provider Pool impermanent loss works on pancakeswap.finance or binance.com.
In this blog, I am going to take two different scenarios to calculate the impairment loss:

On the first one: I become a liquidity provider while in the bull market and calculate the impermanent loss

The second one: I become a liquidity provider while in the bear market and calculate the impermanent loss

At the end show you the result, you will understand what should you be doing if you are also planning to become a liquidity provider on any of above networks. For the better understanding please watch this video as well.

If you remember from my previous post – to become liquidity provider, your both of the assets value needs to be the same in the currency. that is if you are providing liquidity on any pool with worth of 100$ for cake-bnb coin you need to have 50$ of cake and 50$ of bnb as value. With the being clear, let’s get it started.
Scenario first: LP pool impermanent loss explained, while in the bull market
Let’s assume, this is your liquidity provider pool;

  • You have BNB coin worth of 1000 dollar
  • And Cake token coin worth of 1000 dollar

Which gives us paired cake-bnb token coin, let’s say 10 cake-bnb lp token coin (which is worth of 2000 dollar)
Since, we are in the bull market, let’s assume, BNB price is double in the market, but no changes on the Cake price, so now you have
2+1 = 3000 dollar as total in the pool.
Now, to make a balance, your LP pool website will sell some of your BNB to cake and make it to 1.5K worth of BNB and 1.5K worth of Cake.
So, we are in the bull market, it look fine until now, & if, BNB price is double again but Cake price increase by 50% only!
Now you have

  • 1.5K$ worth of BNB x double = 3000
  • 1.5K worth of cake x 1.5 = 2250
  • In total = 5250 balance in the pool.

And, to make a balance again, your LP pool website will sell some of your BNB to cake and make it to $2625 worth of BNB and 2625 worth of Cake.
Here is your impermanent loss :
If you simply held your coin to your wallet:
Now you could have 1000 usd worth of BNB which is increased by 4 times i.e. 4000
and 1000$ worth of cake token coin increased by 50% that will give us 1500 dollars in total you have (4000+1500) 5500$ since you invested on the liquidity pool now you have a total of 2625 of bnb and 2625 of cake token coin which in total is 5250.
250$ is your impermanent loss even during the bull market.

Scenario second: LP pool impermanent loss explained, while in the bear market
Now let’s talk about the different scenario let’s go to the bear market the market is going down now and you are providing the liquidity let’s take an example for the same pair of coin that we have a bnb which is worth of 1000 dollars and we have a cake token coin which is worth of 1000 dollar.Which gives us 10 cake-bnb lp token coin which is worth of 2000$ let’s assume we are in the bear market the bnb price is decreased by 50% in the market but there is no changes on the cake price.
Which mean, now you have a 500 bnb plus 1000 cake that is 1500 as a total in the liquidity pool.
Now to make a balance your lp pool website will sell some of your cake to bnb and make it to 750 worth of bnb and 750 worth of cake token coin this is not over yet let’s assume market is still going down let’s take a look more…
And if bnb and cake price decrease again by 50% and 30% respectively now you have a 750 worth of bnb that is decreased by 50% and it will be 375 and 750 worth of cake token coins which is decreased by 30 percent and you have 525. In total you have a 900 dollar as a balance in the pool and to make a balance again your lp pool website will sell some of your cake to the bnb and make it to 450 worth of bnb and 450 worth of cake token coin.
Here is your impermanent loss
If you have simply held your coin to your wallet now you could have 1000 worth of bnb which is decreased by 50% first and 50% later that would be 250 and 1000 worth of cake decreased by 30% which is 700$. In total you could have 950 dollar. Since, you invested on the liquidity (lp) pool now you have a 450 worth of bnb and 450 worth of cake token coin, which in total is 900$. and the difference 50 is your impermanent loss while being in the bear market.

What is impermanent loss:

The impermanent loss described as a temporary loss of the funds occasionally experienced by the liquidity provider because of the volatility in the trading pair this also explains how much more money someone would have had if they simply held their asset into the wallet instead of providing the liquidity.

What are the best option to earn passive income while avoiding the impermanent loss

For the example of impermanent risk free passive income coins – i’ll be relying on the example that available on the pancakeswap.finance or the binance.com there are lots of stable coin are available as a liquidity provider. The stable coin also known as fiat currencies, if you provide the liquidity to the stable coin you will have risk free passive income while providing the liquidity to the pool. Some example you can choose to invest on the busd tusd usdc usdt dai or busd usdc or bust usdt or busd oh there are lots of it you just need to find them the apr (annual percent return) of the coin would be around 7 to 18 percent depend on the liquidity on the pool and the network but they are stable coins so no matter how volatile the market is you will have your assets safe and you will receive your passive income.

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