How to avoid Impermanent losses: 5 ways

Impermanent losses are a real problem for liquidity providers. This is the reason why LPs (Liquidity Providers) have concerns when choosing a pool. In this article we will discuss the main ways of safe liquidity providing and answer the main question: how to protect against impermanent losses?

What is Impermanent loss?

Impermanent losses (IL) are losses associated with the change in value of assets invested in the liquidity pool compared to holding those assets outside the pool. To calculate IL you must calculate how much money you would have had if you had not put it in the liquidity pool, but just held it in your wallet.

Occurrence of Impermanent losses

Let's consider the example of trading pair NOT/TON, so the impermanent loss will occur if:

• TON grows and NOT falls and conversely.
• TON grows and NOT remains at the same level and conversely.
• TON falls and NOT stays at the same level and conversely.
The following follows: You, as an LP, want the assets in the pool to not change their price. Where can we observe this? That's right, in pools with two stablecoins, and so we move smoothly to the first point.

1. Provide liquidity to the Stableswap pools.

Indeed, there are liquidity pools where both assets are tied to a fixed price tag (USD). And don't just think about USDT and USDC. There are many stablecoins on different blockchains. For example, STON.fi, the largest DEX on the TON blockchain, has a relatively recent pool of AquaUSD/USD₮. However, there is a significant downside to this method. As a rule, such pools are very popular among LPs, and as a consequence, low APR due to high TVL. Therefore, such liquidity pools should be considered only as a long-term investment.

2. Provide liquidity to pools with different ratios.

There are liquidity pools where the token ratio is not 50/50. Sometimes platforms adjust this ratio to minimize risks for liquidity providers. After all, if you put liquidity in a pool with a 98/02 ratio, and the price of a token with a smaller portion changes, you will hardly feel such a loss. Moreover, there are pools where the ratio changes right on the fly, but personally I have not yet encountered such platforms.

3. Provide liquidity to pools with farming

Some DEXs offer users additional rewards in tokens for provding liquidity, also called farming, and pools with such rewards are called farms. So, these extra rewards can make up for your losses. You may notice a lot of farms on STON.fi, let's take a look at a few of the current ones:

JETTON/TON - 46.32% farm APR. Reward distribution: $220.66 / day (in JETTON tokens)
MY/TON - 86.33% farm APR. Reward distribution: $455 / day (in STON tokens)
AIC/USDT - 632% farm APR. Reward distribution: $2840 / day (in STON tokens)
To participate in farming, you need:

1. Go to the STON.fi website

2. In the “Pools” tab, sort the liquidity pools for the presence of Farming and select the pool you need by clicking on it.

3. Click "Add liquidity"

4. Provide liquidity in a bear market

When the price of tokens in the liquidity pool falls for a long time, the trend is likely to change and the price will go up, so providing liquidity on a drawdown is a great idea. But then you would have the question, “can't the coins go up in an even ratio?”
Yes, you're right, but even if you suffer impermanent losses on the upside, it's better than suffering impermanent losses on the downside. This method works more as an additional, rather than primary reason to provide liquidity. It can add to your confidence, but it is a mistake to be guided by it alone.

5. Avoid highly volatile assets

The final piece of advice may sound trivial, but it is worth mentioning. As an LP, you should avoid any highly volatile pairs, as they pose the greatest risk to you. These include coins that have been listed recently and coins with low liquidity. On STON.fi there is an exclamation mark icon next to such pools, warning the user about the possible risk of impermanent loss. Pools with these coins may have a very high APR, but the risk increases with the APR - just ignore such liquidity pools.

6. Bonus

Recently STON.fi announced the Impermanent Loss Protection feature, which works only in the STON/USDT V2 liquidity pool. The protection works automatically and compensates up to 5.72% Impermanent losses, which corresponds to a 50% decrease in the asset price. At the moment the function is disabled and expired, but we can hope for an extension. Stay tuned.

Conclusion

Let's summarize all of the above, but from the perspective of a bad LP. So, if you want to be affected by volatile losses, you need to:

1. Ignore liquidity pools with two stablecoins
2. Ignore liquidity pools with different ratios
3. Ignore farming on STON.fi
4. Provide liquidity only in a bull market
5. Provide liquidity onlu in highly volatile trading pair.

Learn more: ★★ Impermanent loss | STON.fi: The Ultimate Guide
★ What is liquidity pool | STON.fi: The Ultimate Guide