Know about divergence loss before jumping into liquidity pool
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Know about divergence loss before jumping into liquidity pool

By Smendel | Allaboutcoins | 31 May 2021


Defi is on fire, but it also comes with one fundemental default from formula it uses, which is divergence loss, previously called impermanent loss. It's a result of coin price change.

If you pool LP liquidity into exchange, you could potentially suffer from higher loss from divergence loss than the income fee you make. You will find out that your stake of liquidity has less value if you withdraw at the wrong time. Of course, they tell you that the loss is just a book value until you withdraw. But that's also given one day coin price can go back to original level. What if it will never happen?? 

I entered the pool at the wrong timing couple days ago myself. I saw there is potential APY of 32% by providing BNB-BUSD LP liquidity to the pool at Binance exchange. I have both BNB and BUSD in the account, if I simply keep BNB and BUSD in the saving account, I get expected APY of 0.5% and 5% respectively. So I told myself, "why not join the liquidity pool and make 32% APY!", it sounds like no brainer! 

Unfortunately when I entered the pool, the BNB price was still at $379. I completely forgot about possibility of divergence loss and how volatility current market is toward bear. BNB price dropped down to around $300 since then. The daily income fee is far less to cover the divergence fee  showing on my account. The ratio of BNB-BUSD LP is automatically readjusted following current market price. 

For now, I will continue to keep the LP in the pool, and pray that BNB price will go up. Given its historic performance, there could be good chance that it will. It's just a matter of time I sheepishly wish for. As soon as it goes back to the previous price, I will withdraw the LP right away. I could've been in a much better situation by simply HODL... 

Volatility increases liquidity, the more transactions and arbitrage opportunity, the higher income fee you can get, however, it does come with a potential price, which is divergence fee, you will need to be able and willing to weather out divergence loss from price fluctuation... 

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