Only Unicorns have what it takes to play in Uniswap land
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Only Unicorns have what it takes to play in Uniswap land

By JonathanStanley | cryptonalysis | 2 Jan 2022


There's a 97.3% chance that providing liquidity on Uniswap would cause you lose money.  Here's why:

If we take the estimated 11M Ethereum addresses with balances > 0.01 ETH and compare it to the 290k with balances over 10.0 ETH, we see that only 2.7% of Ethereum addresses have sufficient funds to have a chance at making a profit.  In short, the fees to play will often wipe out any earnings. 

Even before considering the risks, providing liquidity is really only an option for whales. Let's break it down:

Costs to Provide Liquidity on Uniswap

Assume you are bullish on a particular asset and want to earn some extra while you hold it.  For this example, assume

  • ETH is worth $4,000 USD
  • You have 10 ETH ($40,000 portfolio value)
  • You want to provide liquidity ETH with an equal range up or down from the current price
  • Gas fees are 50 GWEI

1: Obtain another token for liquidity 

Swap fees can be .01%, .05%, .3%, or 1%

USDC is the most common at the moment, so let's say you convert 5 ETH.  Thankfully the swap fee is only .05% you have to pay to the existing liquidity providers, so the exchange will cost you 0.0025 ETH ($10).  But there could be some slippage in the transaction, meaning you lose another 0.0025 ETH ($10).  And, you also have to pay the miners to record the transaction on the blockchain.  At 50 GWEI, this will run you another 0.005 ETH ($20).  So your 5 ETH - .0025 -.0025 - .005 ETH = 4.99ETH * 4000 = $19,960 USDC.

Portfolio is now 5 ETH, and $19,960 USDC: total value 9.99ETH / $39,960.

2: Add liquidity

The Uniswap V3 contract will mint you an NFT to record your liquidity and it is fairly gas thirsty.  You planned to add $19,960 USDC and 4.99 ETH, but the transaction cost is too high and you don't have enough ETH for the fees.  You drop it to $19,900 USDC and 4.975 ETH.  The transaction fees paid to the miners costs you .025 ETH ($100).

Portfolio is now Uniswap NFT for ETH and USDC currently valued at $39,800, and the $60 remaining USDC: total value 9.965 ETH / $39,860

3: Collect fees

to keep the math simple, we're just going to assume you immediately withdraw and will discuss your collected fees later.

4: Remove liquidity

You remove your $19,900 USDC and 4.975 ETH.  The transaction fee to the miners to record the withdrawal costs you .025 ETH ($100).  

Portfolio is now 4.95 ETH, and $19,960 USDC: total value 9.94 ETH / $39,760.

5: Consolidate to original currency

The reverse operation of step 1, you swap your $19,960 USDC and pay the swap fees, miner fees, and slippage.  

Portfolio is now 9.93 ETH: total value 9.93 ETH / $39,720

6: Total costs

The costs for the full cycle were .07 ETH ($280), but this is likely the best case scenario.

  • Gas fees often reach 150 GWEI. Triple the miner fees would make the total costs reach .18 ETH ($720).
  • A 1% swap fee would add another .0945 ETH ($378)
  • High gas fees and high swap fees could make the cycle be .07 ETH + .18 ETH + .0945 ETH = .3445 ETH ($1378)

Now come the risks

To break even, a liquidity provider must at least cover the fees (which in our example could range from .07 ETH to .3445 ETH). Suppose you choose a range of 10% from the current price. 

If the price diverges beyond this range, you cease earning fees.  The market at time of writing shows this ETH/USDC pool with a 10% range would yield about 0.1% per day = .00995 ETH ($39.8) per day (of course YMMV).   This sounds like you're getting a 36.5% APR... but that's before costs.

In the best case:

  • If it lasts 1 day, you paid .07 ETH ($280) and made .00995 ETH ($39.8)
  • If it lasts 7 days, you break even

In the worst case

  • If it lasts 1 day, you paid .3445 ETH ($1378) and made .00995 ETH ($39.8)
  • If it lasts 35 days, you break even

And this still doesn't account for divergent loss (also known as impermanent loss).  If ETH rises more than 10%, the portfolio is now composed entirely of USDC.  If you want to gamble that the price will come back down, you can simply wait (but you won't earn any fees during this time).  If you're wrong and the price doesn't come back down, you have lost the increase and must pay additional $ to restore your previous 10 ETH. If ETH drops more than 10%, the portfolio is now composed entirely of ETH.  You can keep your position just as if it were ETH, however you are not earning any fees.

You may also choose to provide a wider range of liquidity, however this dilutes your earnings and also increases your exposure to divergent loss. So if you chose +/- 50%, your earnings are reduced to 0.017% per day and you will incur a 2% divergence loss once the price gets out of this range (118 days of fee earnings to break even).

And you may also choose a narrow range of liquidity, however this means the price will likely exit your range more quickly and cause you to incur substantial fees.  Unless you have enough capital to get a big chunk of the pool and outweigh the fees, this would lose money for you.

Summary

Since you are unable to predict the future, you will not know how long the price will stay in your range.  Unless you're treating it like a gambling trip to Las Vegas, you'll want to have a predictable return. To make a predictable return, you likely need 10, 20, or 100 ETH.  But the records show that only 290k addresses have 10+ eth, and only 52k addresses have 100+ eth.  Compared to the 10.6M addresses that have more than .01 ETH, only 2.7% of addresses are reasonably qualifed and only 0.49% have 100 ETH to really perform with Uniswap.

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