What Is Impermanent Loss and How Can Derivatives Mitigate It?
Impermanent loss (IL) is the temporary loss of funds a liquidity provider experiences when the price of their deposited assets changes compared to simply holding them. Derivatives, specifically options, can mitigate IL by allowing the DAO to buy a put option on the volatile asset in the pool, insuring against a sharp price drop that causes IL.
Glossar
IL Insurance
Protection ⎊ IL Insurance, short for Impermanent Loss Insurance, offers a crucial layer of protection for liquidity providers (LPs) in automated market maker (AMM) protocols.
Impermanent Loss
Exposure ⎊ Impermanent loss, a risk inherent in automated market maker (AMM) protocols and liquidity provision, arises from price divergence between assets deposited and their subsequent value upon withdrawal.
Concentrated Liquidity
Allocation ⎊ Concentrated Liquidity represents a strategic deployment of capital within automated market makers, notably on decentralized exchanges, shifting from a uniform distribution to a targeted provision around specific price ranges.
Liquidity Provider
Provision ⎊ The role of a Liquidity Provider (LP) within cryptocurrency derivatives, options trading, and broader financial derivatives ecosystems centers on actively supplying capital to facilitate trading and reduce market friction.
Derivatives
Instrument ⎊ Derivatives are financial instruments whose value is intrinsically linked to, or "derived" from, an underlying asset, benchmark, or rate.