What Is “Impermanent Loss” and How Does POL Mitigate Its Risk for the Protocol?
Impermanent loss (IL) is the temporary loss of funds an investor experiences when providing liquidity to an Automated Market Maker (AMM) pool compared to simply holding the assets. It occurs due to price divergence between the two assets in the pool.
For a DAO, Protocol Owned Liquidity (POL) mitigates this risk because the protocol owns the loss, but the long-term benefit of stable liquidity and fee capture often outweighs the IL, treating it as a cost of doing business.
Glossar
Impermanent Loss
LiquidityRisk ⎊ Impermanent Loss quantifies the temporary divergence in value between holding assets in a decentralized liquidity pool versus simply holding those same assets in a non-interest-bearing wallet, resulting from price movements between the deposited pair.
Price Divergence
Discrepancy ⎊ Price Divergence occurs when the quoted price of an asset or derivative across two different venues or instruments deviates significantly from their theoretical parity relationship, creating an arbitrage opportunity.
Liquidity Pool
Pool ⎊ A liquidity pool, within the context of cryptocurrency derivatives and options trading, represents a centralized reserve of tokens locked in a smart contract, facilitating decentralized trading and price discovery.
Automated Market Maker
Architecture ⎊ Automated Market Makers (AMMs) represent a paradigm shift in decentralized exchange (DEX) design, moving away from traditional order book models to a constant function market mechanism.
Concentrated Liquidity
Allocation ⎊ ⎊ Concentrated liquidity represents a departure from traditional automated market maker models by enabling liquidity providers to specify precise price ranges where their capital will be deployed, fundamentally altering capital efficiency.
Protocol Owned Liquidity (POL)
Asset ⎊ Refers to the portion of liquidity within a decentralized exchange or lending protocol that is directly owned and controlled by the protocol's treasury or smart contracts, rather than by external liquidity providers.