Impermanent Loss

What is Impermanent Loss?

Impermanent loss occurs when the value of your assets in a liquidity pool is lower at withdrawal than at the time of deposit. It’s also known as unrealized profit, as sometimes it may be more profitable to simply hold your assets in your wallet.

However, impermanent loss doesn’t become a real loss until you close the position, and it could recover if prices return to their original levels.

Why does it happen?

Impermanent loss happens in liquidity pools that contain volatile tokens. When you provide liquidity on TONCO in V3 pools, you supply two tokens in a specific ratio based on price range. If the price of one of the tokens changes, the pool adjusts and rebalances, changing the asset ratio.

Impermanent Loss in TONCO DEX

• The minimal IL — is a loss that occurs when the price in a pool changes, causing the asset ratios to change as well. The position continues to earn fees, but the dollar value of the current asset amount and the initial position differs. This type of IL is unavoidable but can be reduced by narrowing the position price range.

• The out-of-range IL — is a loss that the position suffered when the pool price exceeds the set price range. When the price goes out of the range, the position, there is only one asset left and not earning trading fees until the price reenters the range. While the position ratio is frozen in overweight to the falling asset, the position does not bring any LP rewards. The difference between the dollar value of the initially supplied position and the frozen position is the out-of-range impermanent loss. This loss can be avoided without any losses in profit by withdrawing the position immediately after it falls out of range and redepositing it back with a new ratio.

HODL or Provide liquidity?

When deciding whether to hold tokens or provide liquidity to any pool on TONCO, it depends on the market’s movement and your strategy.

Holding may outperform LP during a bull run, but LP can provide consistent fees during sideways or down markets. LP offering potential gains through fees while mitigating some market risks.

Rebalancing is essential, and LP can protect against price drops by earning fees, which may offset impermanent loss depending on the pair and range.