We wrote about yield farming in our last post and had a basic concept. On this one, we will talk about the dark side, which is impermanent loss. We will also give you some tips on avoiding getting wiped out.
As always, we start with the definition of what this is. In DeFi, there is no straight answer to anything since things evolve so fast so never depend on one resource (including us), so here we go. According to Binance, they define it as follows:
“Impermanent loss happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them. The bigger this change is, the more you are exposed to impermanent loss. In this case, the loss means less dollar value at the time of withdrawal than at the time of deposit.”
Coinmarketcap describes it as:
“Impermanent loss describes the temporary loss of funds occasionally experienced by liquidity providers because of volatility in a trading pair.”
Another definition is:
“Impermanent loss is a unique risk involved with providing liquidity to dual-asset pools in Defi protocols. It is the difference in value between depositing 2 cryptocurrency assets within an Automated Market Maker-based liquidity pool or simply holding them in a cryptocurrency wallet.”
our definition would be the following:
“The loss of assets while providing liquidity due to the devaluation of the provided asset.”
If you still don’t get it. Here are some videos:
So now you have a grip on this and why yield farming can be risky. Currently, there are things you can do to lower your risk. This does not mean you will be safe but just safer.
Provide liquidity with stablecoins.
Technically stablecoins are supposed one to one with a currency, but sometimes that is not the case. However, it is a more stable way to earn yields. Yield farming with things like USDC or Tether is not as profitable as Ethereum or another crypto, but it’s safer.
Put liquidity where you get more than you provide
There are some decentralized exchanges that you will get more bang for your crypto mainly in their own currency. The downside to this is that they are mostly new projects and their token can decrease in value really quickly. If they offer proof of stake you can always put the native token to work and then decrease or remove your liquidity.
Have an exit plan.
Yield farming is not forever; it may last months or even weeks. So as soon as you make a certain amount of profit, you should consider getting out while you can. Don’t be greedy.
Invest money you can afford to lose.
The number one rule in investing is that: Nothing is certain or promised, so whatever you put into yield farming, you may not get it back. So try to put money that you can afford to lose; never put your eggs in one basket. If you do, you’re gambling and not investing.
Always take into consideration that you may lose money while trying to get more returns. There is always a risk with everything in crypto but there are amazing rewards as well. So enjoy, learn and try not to get rekt.
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