HOW TO DEAL WITH IMPERMANENT LOSS IN LP STAKING

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Among several ways of generating passive income, LP staking is one of the most popular methods. People prefer it to naked staking ( staking of a single asset) mainly because it offers higher interest, but just as nature has it, anything that has merit will have a demerit as well. Impermanent Loss is the main challenge faced by liquidity providers when it comes to farming a token.

WHAT IS IMPERMANENT LOSS?

Liquidity providers combine two different tokens to form an LP token which is supplied to an Automated Market Marker ( AMM). They are thus opportune to earn from both trading fees and pool rewards. To be able to combine two tokens to an LP token, the two tokens must be of equal monetary value., their quantity can vary. For example, 1 BNB requires 100 USDT ( assuming 1 BNB is $100). This makes the total capital investment amount to $200. For supplying LP to a pool, the provider receives a percentage share of the pool. For this case, let's assume that his share of the pool is 10℅ and that the total pool is 10 BNB and 1000 USDT.

When there is a significant change in the price of one/both of the coins supplied, the monetary value of the supplied assets will be affected. For the case of the USDT- BNB pair above, if 1 BNB should rise to $400, and the liquidity provider wants to sell his BNB and take away profit, he will only withdraw 0.5 BNB and 200 USDT, amounting to $400( this is because arbitrage trading has reduced the 10 BNB in the pool to 5 and increased the USDT to 2000). But if he had held the tokens in his wallet up till the time that 1 BNB rose to $400, he would have a total of $500 ( $400 from his 1 BNB and his 100 USDT)This is where impermanent loss comes in.

The loss is impermanent because you will only lose if you sell at the time when one of the tokens combined to form an LP token has risen or fallen significantly.

HOW CAN YOU DEAL WITH IMPERMANENT LOSS?

Whenever you want to engage in LP farming, ensure that it is with tokens that you intend to hold for long and that you are more interested in the token you are farming as a reward. With this, you won't be moved to sell the tokens once there is a rise, also the reward you are farming becomes what you are concerned with for the specified period you want to provide the liquidity.

Monitor the market whenever you want to withdraw the LP, ensure that you are withdrawing the tokens in a period when the market is neither on a bull nor on a dip.

Finally, don't be discouraged by the so-called impermanent loss because the reward you will generate from trading fees and the token you are farming is usually far greater than whatever loss you might incur due to market volatility.
Below is a table that shows how many losses you can incur with each percentage loss.

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