The APY Number Doesn't Tell You the Whole Story
A pool advertises 20% APY. A trader deposits equal value in two tokens, checks back a month later, and finds the position worth less than if they'd just held both assets. The rewards were real. The loss was also real.
This is impermanent loss, and it rarely makes it into the marketing.
Most AMM pools use a constant-product formula, holding two assets in a ratio that shifts as traders swap between them. When one asset rises relative to the other, arbitrageurs trade against the pool until its price matches the market. That process pulls the stronger asset out of the pool and leaves the depositor holding more of the weaker one.
The loss scales with price divergence, not time. A 5% move between paired assets creates a small loss. A 50% move, common between a volatile altcoin and a stablecoin, can outpace months of reward emissions. This is also why the highest APY pools often carry the highest impermanent loss risk: protocols raise emissions specifically to attract liquidity into pairs that are harder to balance.
Take an ETH-stablecoin pool. Deposit $5,000 of each. If ETH rallies 40% while the stablecoin stays flat, arbitrage pulls ETH out of the pool and pushes stablecoins in, rebalancing back toward 50/50 by value. The depositor ends up holding less ETH than if they'd simply held it.
Modeling that scenario, a 40% divergence produces an impermanent loss of roughly 4-5% versus holding. A 20% APY sounds like it easily covers that. But APY is an annualized rate based on current conditions. The actual yield accrued over the weeks it takes for a 40% move may only be a fraction of that headline number.
A pool of two stablecoins carries minimal impermanent loss since both assets track the same value. A pool pairing a volatile token against a stablecoin, or against another volatile token, carries a structural cost that grows exactly when the market is moving the most.
The correlation between paired assets matters more than the APY figure itself.
#DeFi #Crypto #Trading #RiskManagement #Markets
A pool advertises 20% APY. A trader deposits equal value in two tokens, checks back a month later, and finds the position worth less than if they'd just held both assets. The rewards were real. The loss was also real.
This is impermanent loss, and it rarely makes it into the marketing.
Most AMM pools use a constant-product formula, holding two assets in a ratio that shifts as traders swap between them. When one asset rises relative to the other, arbitrageurs trade against the pool until its price matches the market. That process pulls the stronger asset out of the pool and leaves the depositor holding more of the weaker one.
The loss scales with price divergence, not time. A 5% move between paired assets creates a small loss. A 50% move, common between a volatile altcoin and a stablecoin, can outpace months of reward emissions. This is also why the highest APY pools often carry the highest impermanent loss risk: protocols raise emissions specifically to attract liquidity into pairs that are harder to balance.
Take an ETH-stablecoin pool. Deposit $5,000 of each. If ETH rallies 40% while the stablecoin stays flat, arbitrage pulls ETH out of the pool and pushes stablecoins in, rebalancing back toward 50/50 by value. The depositor ends up holding less ETH than if they'd simply held it.
Modeling that scenario, a 40% divergence produces an impermanent loss of roughly 4-5% versus holding. A 20% APY sounds like it easily covers that. But APY is an annualized rate based on current conditions. The actual yield accrued over the weeks it takes for a 40% move may only be a fraction of that headline number.
A pool of two stablecoins carries minimal impermanent loss since both assets track the same value. A pool pairing a volatile token against a stablecoin, or against another volatile token, carries a structural cost that grows exactly when the market is moving the most.
The correlation between paired assets matters more than the APY figure itself.
#DeFi #Crypto #Trading #RiskManagement #Markets