The Tomb Fork Saga : Chapter 8

Impermanent loss, the trap of the LP stakers

When I woke up the next morning, I was still feeling confused by the dead body from 2018 I had found yesterday evening. I went directly to the 2omb casino to get a breakfast and my round of freshly minted 2omb tokens.

Was I already a yield addict?

In the second room of the casino, everybody was smiling. Bottles of Champagne were being ordered here and there. A band was playing some nice music. 2omb had risen again, and was now trading at 1.57 FTM. 2shares had risen too and were now trading for 673 FTM. I had bought mine just 4 days ago at 357 FTM. Not only was I getting funny FTMs in the form of over priced 2ombs, but the investment I had made to get into that dodgy business had almost doubled in value. Not too bad in the middle of a bear market.

Around me, share holders were still swapping their fresh 2ombs for more 2shares. Here, the richer you get, the faster you get richer. That’s the magic of compounding.

I still wasn’t ready to re-invest my 2ombs into more 2shares. I had dreamt again of this Otis elevator descending in the dark during the night. So I went into the first room of the casino, and sold my freshly minted out of thin air 2ombs for some real FTM, but for 1.57 each, this time.

Crypto advocates had been shouting for years that the central banks money printing was the mother of all evil. Now that money was being printed directly into their wallets, money printing did not seem to be that much of an evil any more.

Tensions in the first room

That time, I lingered a while in the first room of the casino. I looked at a bunch of fresh newcomers. Their eyes were glinting with excitement, at the expectation of soon receiving a small amount of 2shares. They had none yet, so they had not yet access to the casino’s second room.

I continued to glance around at other clients. This was the room of LP stakers. I looked at a group of them, sitting together drinking beer. They did not seem that happy. I was a bit puzzled. Ok, they were not getting rewards as juicy as the rain of 2ombs that the 2share holders were enjoying in the second room of the casino, but they still benefited from the trading fees paid on the FTM-2omb, weren’t they?

Impermanent Loss calculator

Here comes impermanent loss

I spent a few hours lingering in the room. Eavesdropping here and there, focusing on the people that looked the most unhappy. After hearing some bits of conversations at different tables, I could put all the pieces together.

When you provide some liquidity in a pool, you take on the risk of impermanent loss. Impermanent, because, as long as you don’t return your LP tokens to take you money back from the pool, you’ve lost nothing yet. Loss, because actually, when the relative value of the two coins you provided shifts, you take a loss. There are many impermanent loss calculators you can play with to figure that out.

To make it simple: if you provide liquidity when one 2omb = one FTM, and later one 2omb = 2 FTM, you take a 5% loss*. Honestly, that is not that bad. Especially considering that 2omb is supposed to be pegged to FTM with clever incentives. I’d consider this as a small loss with low risk ... and the casino wants me to think that way.

But if things get really ugly and 2omb runs far away from the peg, then LP stakers are going to feel it. If for any reason, at some point in time, one 2omb trades for ten FTM, or ten 2ombs trade for one FTM, then impermanent loss creeps up above 40%. And it only gets worse as the tokens deviate more in value.

Impermanent Loss is the nightmare of liquidity providers. The more volatile the pair, the higher the IL risk. That is why many people don’t provide liquidity to pools, because it’s too risky. Except if you have the chance to find a pool with two different assets that are stable, one compared to the other. Like an algo pegged stablecoin for example …

It's a trap!

It’s a trap!!!

With the algo-stable-coin-pegget-to-FTM mantra, 2omb Finance makes you think that there is hardly any impermanent loss risk to provide liquidity to their casino. But if things get ugly, the LP stakers are the ones that will take the hit. And when you’ve invested in something that has impermanently make you loose 40% of your stake, what do you do?

• Take the hit. Get what’s left of your money back, and make that impermanent loss permanent?
• Or do you go to church and pray the balance will swing back on your side?

This was very interesting: because LP stakers had a lot to loose if the ship was sinking, it gave them a strong incentive to HODL to their LP tokens. Maybe that would be enough to save the ship during a storm.

https://www.timeout.com/newyork/things-to-do/beautiful-churches-in-nyc

I left the 2omb casino to breath some fresh air. Wandering around, I passed by one of the churches of the area. If was an old building. Neo-gothic as I am so fond of. It was built long before any of these new casinos. I thought to myself that maybe in a week or two, it will be full of panicking LP Stakers praying, while their LP tokens would be getting wrecked by the unfaithfuls that would be leaving the ship before them.

Next to the church was a little graveyard. I like graveyards. I always liked to walk in le cimetière du Père Lachaise when I was living in Paris.

But the tombs I was about to discover would make me run back to the 2omb casino.

Next: The Walking Deadcoins: Basis Cash

[*] : to be precise, the impermanent loss is between the two following strategies: provide liquidity vs hodl. Say you provide liquidity to the FTM-BOO pair. BOO shoots up from 25$ to 500$, and FTM goes only from 2$ to 4$. You end up with 40% impermanent loss. Meaning, you would be 40% richer if you just had kept FTM and BOO in your cold wallet. But as FTM has done x2, and BOO has done x10, your impermanent losses are quite compensated by the rise of the two underlying assets. Still, you would have been 40% richer, had you not provided liquidity.