Impermanent Loss
Today I want to talk about Impermanent Loss, but a not with math or graphs, but in my words. I think you will fear it a lot less and you will be more comfortable with
providing investing as a Liquidity Provider in a Yield Farm, in a decentralized finance project.
First let’s define it differently in terms of choice, because choice is a universal concept.
When you decide to invest your money, you are making a choice between two or more different investments. For example, you could choose to invest in gold, you could choose silver, Bitcoin or Ethereum. The important word here is choice. And of course here we are talking within the context of choosing to be a Liquidity Provider in a Yield Farm, in a decentralized finance project.
If you choose gold, that means you didn’t choose silver, Bitcoin and Ethereum. If you choose gold and silver, that means you didn’t choose Bitcoin and Ethereum.
Choice. If you choose to hold your cryptocurrency assets in your wallet. That means you made a choice not to be a Liquidity Provider in a Yield Farm, in a decentralized finance project.
Results
Once we choose our investment we wait to see the result. The result is that the price of the asset goes up a little, goes down a little, the price goes up a lot, the price goes down a lot, or the price stays the same. Then we decide if we made good or bad choice based on the result.
A positive result is we make a profit. A negative result is we lose money. The important word here is result. What I am writing about today is the difference in result we can get by either holding our chosen cryptocurrency investments in our wallet or holding them in a trading pair as a Liquidity Provider in a Yield Farm, in a decentralized finance project.
Choices and Impermanent Loss
Based on your choices of asset you choose, you will make money, lose money, or you won’t make or lose money. This is the important concept we now want to use, to explain impermanent loss. Because impermanent loss is really about choices and results.
Liquidity Providing is an investment choice.
The choice is to invest our money in an asset trading pair, is just like choosing gold and silver over Bitcoin and Ethereum. The main result of any investment decision is that the price or value of the asset we invest in, goes up, goes down or stays the same. We then decide if it was a good investment, based on the change in price or asset value. Here we are discussing whether being a Liquidity Provider in a Yield Farm, in a decentralized finance project is a good investment choice.
Being a liquidity provider is the second decision or choice we have, after we choose which cryptocurrency assets we are going to choose as an invest vehicle.
Then we choose how we hold those assets, either in a wallet or in an asset trading pair on an exchange. The first choice, a wallet, usually means we earn no income on our invested money other then through asset price increase or price appreciation. The second choice, holding those same assets in a exchange trading pair and either earning transaction fees or exchange tokens means we earn income two ways, through price appreciation, and through transaction fees. This extra income is one advantage of of that second choice effects our result. The second choice is to be a Liquidity Provider in a Yield Farm, in a decentralized finance project.
This choice is different from our first choice of choosing what to invest in because it has the effect of increasing or decreasing the result of our first decision.
What I mean is our first decision really determines if we have a positive or negative result. Our second decision, how to hold the asset will have two effects. The first effect is how big or how small the gain or loss is. The second effect is it determines if we make money only when we sell the asset or if we make money while we hold it.
We have a choice of how to hold our assets.
We chose to hold our two assets Bitcoin and Ethereum in our wallet or in a trading pair. This is important to understand.
Choice A:
We hold our Bitcoin and Ethereum in our wallet. We are hoping the price or value of both of them goes up. So we wait to see if number go up, number go down or number stay the same. This is an investment choice.
Choice B:
We hold our Bitcoin and Ethereum in a trading pair. We are getting paid every day for holding them in the trading pair. (Transaction fees) Liquidity Provider in a Yield Farm, in a decentralized finance project.
The results
The main thing to understand is that if we hold Bitcoin and Ethereum in our wallet we earn 100% of the increase in value if their prices go up. And we earn 100 percent of the loss if they go down.
The second thing is that if we hold the assets in a trading pair instead of a wallet. We don’t earn 100% of the increase in price, if the price goes up. But we also don’t suffer 100% of the loss, if the price goes down.
When people refer to impermanent loss, what they are really describing is the difference in how much of the increase in price you get when your holding the assets in your wallet versus holding the assets in the trading pair. This loss isn’t a loss in a the strict definition of losing money. It’s better described as a lower profit.
Lastly, it’s just as important to remember, that just like holding your assets in a trading pair reduces the percentage of gain you enjoy, it also reduces the amount of loss you suffer. Remember that if you hold the assets in your wallet, you own 100% of the gains, but you also own 100% of the losses.
If you hold your assets in a trading pair, you give up some of the gains, but you are also protected from some of the losses. But you may be quite happy with both the reduced gains and the regular income being a liquidity provider produces. It’s great to make money without selling your asset and sharing in long term price appreciation. I think this is why many investors are choosing to get involved in DeFi, liquidity provision and Yield Farming.
Once you understand this you realize that holding your assets in a trading pair means you have impermanent loss if the price goes up, and impermanent gain when the price goes down. No one ever talks about impermanent gains! But it is another result of our choice to be a Liquidity Provider in a Yield Farm, in a decentralized finance project.
Why?
Transaction Fees
Automatic rebalancing
Other math reasons
Summary
All investments choices have risks and benefits. Those choices start with what assets you choose and how you hold them; on an exchange, in your own wallet or in an exchange as a trading pair. When you chose to be a Liquidity Provider in a Yield Farm, in a DeFi or decentralized finance project. I believe that when you hold an asset in your wallet it’s an investment decision which allows you to realize 100% of the price increase gains, but also 100% of the price decrease losses. If you hold your assets in a trading pair, you give up some of the gains, but you are also protected from some of the losses.
But you may be quite happy with the actual value of those reduced gains and added protection of reduced losses, along with the bonus of the regular income being a liquidity provider produces.
It’s great to make money without selling your asset and sharing in long term price appreciation.
I think this is why many investors are choosing to get involved in DeFi, liquidity provision and Yield Farming.
The total amount of money invested in DeFi currently exceeds 50 billion U.S.D.
IF you interested in getting into DeFi and earning some these returns, but your not ready to do it yourself, join my investment pool 
I have also listed some videos and articles for you to watch or read below.
About 
Shortsegments is a writer focused on cryptocurrency, the blockchain, non-fungible digital tokens or NFTs, and decentralized finance. He has been a community member for more then three years, and has earned a reputation of 75, on a scale of 0 to 80, which puts him in the top 300 of over 20,000 Hive accounts.
He is also a builder, with two current projects:
The first is the No Loss lottery, a prize linked savings account here on Hive, which awards more the 100 Leo in prizes weekly, and which recent surpassed 1000 tickets sold.
His latest project is Easy DeFi, which creates a community investment pool allowing community members not yet confident enough to invest on their own, a chance to easily invest in yield-farming and staking on Cubfinance.
Cubfinance is the Hive communities home grown Yield Farm and is audited by CertiK, a third party which certifies DeFi projects on Ethereum, Binance and polygon ecosystems.
Read more of shortsegments articles here: @shortsegments
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Important Links and References:
Easy DeFi
@shortsegments/the-solution-to-yield-farming-complexity-easy-defi
