Considerations Providing Liquidity
While you are a liquidity provider, your stake is a part of every swap. Every time there’s a swap on the pool, you’re stake changes in two ways: First, it grows, earning part of the 0.3% fee the swapper pays. Second, it changes, representing the new ratio of the two tokens in the pool.
DeFi communities have named this behavior, and the risks it represents, as Impermanent Loss, and there are many good articles, videos, and math-powered papers that explain and model the implications. But a simple way to describe it that we haven’t seen elsewhere is to focus on three possibilities, and for each, talk about the different ways someone might feel. Suppose someone pools some A (an example project token) and D (an example stable token, or something foundational like ETH), waits some amount of time, and then checks the current ratio in the pool. At any moment, the situation might be:
- 1.More D and less A. (This happens when people have wanted more A, and have swapped more D into the pool to get it.) 😃 Someone in this situation might feel happy they can depool, and end up with more D than they put in. 😥 Or, they might feel unhappy they started with a significant share of A, and that quantity has become much less.
- 2.More A and less D. (This happens when people have wanted less A, and have swapped A into the pool to get rid of it.) 😥 Someone in this situation might feel unhappy knowing that if they depooled right now, they would get back less D than they put in. 😃 Or, they might (simultaneously, even) feel happy that they passively grew their quantity of A much larger, without needing to choose when to perform a swap at the current ratio of any one moment.
- 3.No change. (This happens if nothing has happened, or if combinations of the first two situations have restored the ratio to what it was at some earlier time.) 😥 Someone in this situation might feel unhappy because they were hoping for one of the things above to happen, and must either keep waiting, or depool to give up. 😃 Or, they might feel happy because they could depool and get back all the A and all the D they put in, and more from the 0.3% swap fee they’ve earned throughout. (This earning happens throughout all three situations, of course, but is easy to see when the ratio is the same.)
Every pool on SushiSwap and Uniswap has these risks. What are good ways to manage them?
- 1.First and foremost: The most important rule of crypto: Never risk any more than you are willing to lose.
- 2.Find good projects. Realize that even good projects, for reasons within and not within any individual or group’s control, can fail.
- 3.Instead of holding all of example token D, or all A, or pooling all of both and holding all P, choose a mixture of these three methods that you like.
Let’s list out those three methods in more detail:
- 1.If you hold all D, you’re not involved in the project (which is fine!)
- 2.If you swap D to A, your quantity of A will not change, but how much D it represents may.
- 3.If you hold all P, the ratio in the pool may change, representing more A and less D at one time, or more D and less A at another, or be the same. As this happens, how much D the A represents changes.
These risks are not specific to ARA — every token pooled on SushiSwap and Uniswap works this way. We hope with this description of different methods and possible situations in the pool, as well as additional materials and communities you find online (ours and those of other projects), you empower yourself to make the best choices for yourself.