The big problem of liquidity pools

The concept of liquidity pools is an integral part of the web3 world. They provide us with a quick and convenient exchange of tokens between each other: for example, if you exchange $TON for $USDT, you deposit $TON and take $USDT from the TON/USDT pool and vice versa. The liquidity pool, in turn, regulates the number of tokens with its algorithms so that they are always close to a 50/50 ratio, because the fewer tokens there are in the pool, the more the commission is charged. In fact, it is quite a clear mechanism.

Liquidity providers are needed so that the pool's supply of tokens does not run out. In our example, these are the people on whose USDT we get our TONs. They provide liquidity to the pool. And now the tokens from the pool are available for exchange to DEX, which in turn rewards the liquidity providers with a portion of the fees from each transaction made within the pool to which the liquidity was provided.

Being a liquidity provider is a way to earn passive income, but you should be very careful when choosing a pool. Tokens in the pool should be relevant and promising, so that they have as much volume as possible and, as a consequence, a high APR (Annual Percentage Rate). Moreover, it is worth considering the TVL (Total Value Locked). It shows how many competitors you have that share the commission revenue with you. The lower the TVL, the higher the APR.

In the case of STON.fi, a leading DEX on the TON blockchain, we have farming APR in addition to the usual metrics.

What is Farming on STON.fi?

In short, farming is when a liquidity provider (LP) receives additional rewards in tokens for providing liquidity. Projects whose tokens are traded on DEX are interested in having more funds in their liquidity pools so that users can trade in larger volumes. Therefore, the project allocates rewards to the liquidity pool to attract providers.
For example, right now in MY/TON liquidity pool reward distribution is $494 in $STON tokens per day. Farming APR in this pool is 100%, while the normal 24h APR based on classic metrics is 25.12%.

Here are some current liquidity pools with active farming: • JETTON/USDT: 45% APR • MY/TON: 118% APR • PONCH/TON: 214% APR

What are Impermanent Losses?

An impermanent loss occurs when you contribute cryptocurrency to a liquidity pool and the price of deposited tokens changes since the time of deposit. The larger the change, the larger the impermanent loss: in other words, when you withdraw, you will receive less in dollars than you deposited. Such losses occur if the prices of two assets in the liquidity pool are very different. To make it even easier to understand this concept, let me give an example. You have 1 coin with a price of $1000. You give it to a platform that pays you 10% year APR. Thus, if it wasn't for the volatile losses, you would have $1,100 after one year. However, the price of the сoin suddenly halves and you are left with only $550.

Absolutely any difference in the price of tokens in liquidity pools leads to impermanent loss, whether they are a rise or a fall. But the difference between rise and fall is that you lose potential money on the rise, i.e. if you were holding the token and not investing in a liquidity pool, you would have made a profit on the rise. This is why one of the safest ways to provide liquidity is to provide liquidity to Stableswap pools (pools with stablecoins). So you, as a liquidity provider, want the coins to be at roughly the same level, or both rising. And this is a very unpleasant problem, because it is not always possible to predict such drastic changes in the price of tokens.

So what's the solution?

Recently, STON.fi has introduced a new function of protection against impermanent losses. It works automatically (no claims are needed) when providing liquidity to the STON/TON pool and, in case of impermanent losses, compensates losses in $STON tokens up to 5.72% of impermanent losses. (corresponding to a ~50% decrease in asset price). Monthly protection budget is limited to $10,000, but maximum payout per user is $100 (in STON tokens). It is only available in the STON/TON pool.

You can learn more here.

Conclusion

STON.fi makes us happy with its bold innovations. Every time new farming pools appear, old ones are extended or expired, which gives its dynamics and allows liquidity providers to choose the liquidity pool more carefully for liquidity delivery. As for the protection against impermanent losses - it does give us confidence and allows us not to fear for our funds, but only in the STON/TON liquidity pool. I hope this feature will be the same for other liquidity pools in the future.

Just like farming, the impermanent loss protection feature attracts new liquidity providers. This is beneficial for the projects whose tokens are in the pool, which means that we may well expect STON.fi to cooperate with these projects. And then our ability to provide liquidity will expand significantly: another important factor in selecting the right pool will be added. But this is just speculation for now, don't take it seriously (or not?).