Liquidity mining and yield farming which have been in vogue, have brought new and exciting ways to earn passive income. On the other hand, if we talk about the popularity of the DeFi protocol, then there has also been a significant increase in it. DeFi blue chips like SushiSwap, Uniswap, or PancakeSwap have dramatically increased liquidity and transaction volume. DeFi has typically been able to offer new ways to access crypto assets and maximize profits. AMMs such as 1inch and Uniswap allow holders to deposit assets into a liquidity pool while also taking advantage of a percentage of fees. Enter to chain reaction trading system to get the appropriate strategies.
Despite the advantages of DeFi marking, there are a few dangers related to Liquidity Pools (LPs), including rig pulls, cost dumps, and APY diving. As well as “temporary loss” which has emerged as another significant risk associated with it.
What is Perpetual Loss?
The chance of a brief temporary generally emerges when the cost of your tokens seems to have changed compared with the cost at which they were kept in the liquidity pool. However, when the price changes, the amount you lose as a result is a permanent loss. The temporary loss becomes greater the variation. Furthermore, a liquidity protocol based on Automated Market Makers (AMM) usually results when two different cryptocurrencies are pooled. Misfortunes are acknowledged when you pull out resources from the AMM liquidity pool sometime in the not-too-distant future when their worth changes decisively. Nevertheless, there have been some scenarios where you may profit instead of losing money even if the price moves positively. If you want to get better exposure to temporary losses, you must withdraw your funds from the Liquidity Pool.
How can you avoid permanent damage?
Due to the volatility in crypto prices, temporary losses are inevitable. However, these can be avoided. Here we will discuss some of the following steps, which can help you avoid any troubles related to temporary damages
- One of the hottest ways to avoid permanent losses is with stablecoins. Along with low volatility, stablecoins can also provide low arbitrage opportunities, thus mitigating the risks. However, an LP holding can’t advantage of the growth of the stablecoin crypto market.
- Because there is a high amount of volatility involved in the cryptocurrency market, therefore, it is not uncommon for the property you deposit to increase or decrease in value. Nonetheless, it tends to be significant for LPs to know when to pull out their crypto before it creates some distance from the initial worth.
- Stay away from volatile LPs and pairs: Always note that you should make sure to choose pairs with a low volatility history rather than cryptos with a volatile or volatile history. The same connects with LPs, Liquidity pools with volatile assets are found to be more prone than seen for ILs. If you are also looking for ways to avoid temporary losses, then you should avoid Volatile Liquidity Pools.
- Notably, DeFi does not offer liquidity through a two-token liquidity pool; moreover, it consists of a single-token staking pool; Since there is never any proportional balancing between the two assets, any floating losses in such pools are likely to be the same and not come.
Speaking of Liquidity mining, it may be able to fetch lucrative rewards. However, the higher the returns, the higher the risk involved. At the same time, as AMM increases, floating losses are becoming a more common. Therefore, whenever an investor adds liquidity to a pool, it would be prudent for him to consider it carefully before risking permanent loss.