Highlights:

• Analysing impermanent losses in V3 revealed that roughly half of the people who provided liquidity to the protocol lost money, compared to HODLing.
• Uniswap V3 has the highest trade fees among all DeFi protocols, however impermanent lost dominated the income from over 80% the pool analysis.
• The analysis showed that Uniswap Pools generated $199m in trading fee and $260m impermanent loss. This left a net loss over $60m. 49.5% had negative returns.
• Some pools had as much as 70% of negative user returns. These users were found in MATIC/ETH (51%) COMP/ETH (79%), USDC/ETH (62%), COMP/ETH (89%), and (74%).
• The study also found no statistical evidence that users who adjust their positions more frequently performed better than users who don’t, calling into question the widely held belief that “active” LPs outperform “passive” LPs in Uniswap V3.
• Contrary to popular belief, the study showed that LPs who staked more than 1 hour per day lost less on average than those who staked shorter periods.

The cornerstone of decentralized finance has been automated market makers (AMMs). Over $30 Billion has been staked in AMMs on every major blockchain. This generates billions of trading fees revenue each year. AMMs have financial risks that are not well understood. The cost of liquidity provision, also known as impermanent loss, is often overlooked.

A new study uncovers the secrets behind liquidity providers profits in AMMs. An analysis of more than 17,000+ wallets offering liquidity in Uniswap V3 reveals nearly half the users experience negative returns on staked capital because of impermanent losses.

Uniswap V3 has the highest trading fees among all DeFi protocols, but impermanent losses completely wiped off fee income for over 80%.

Only three of 17 pool analyses earned fees exceeding the impermanent Loss.

Seventeen pools were analyzed in the study, accounting for 43% of Uniswap V3’s TVL. The study considered the following factors: size (pools less than $10M TVL were exempted), availability of data and token composition. Pools that were stable and like-kind, such as renBTC/WBTC or USDC/DAI, were not included.

Between May 5th and September 20th of 2021, analyzed pools generated $108.5b trading volume and $199m fee income. But, pools also suffered over $260m worth of permanent loss. This left only 49.5% of the LPs who had negative returns.

Some pools had a high percentage of negative returns, such as MATIC/ETH (51%), COMP/ETH (59%), USDC/ETH (62%), COMP/ETH(59%), COMP/ETH (39%), and MKR/ETH (74%).

The percentage of wallets that are earning (green) and losing (red), is shown on the right. Left, you will see the median returns of winners and losers.

Researchers sought out to determine whether some groups perform better than others, after finding that the average UniswapV3 liquidity provider performed below a simple buy-and-hold strategy. In particular, the study examined whether “active” users who adjust their positions more frequently performed better than “passive” users who don’t.

The pool position’s duration was then compared with the profits made by their LPs. On average, shorter-term position likely belonged to more active members of the pool. If you enter the market but leave within a short time, it is likely that your strategy was preplanned. Those who are active for longer periods of time can be considered to be more skilled or more active. Researchers tested the hypothesis of active LPs performing better by analyzing profitability and duration. It was not possible to find a correlation between profits earned and shorter-term positions. Across all categories, the impermanent losses outpaced the fees earned. This calls into question the commonly held belief that passive LPs are more successful than active ones.

IL vs. the fees based upon position duration

The only group that consistently made money when compared to simply HODLing were just-in-time or “JIT” liquidity providers who provide liquidity for a single block to absorb fees from upcoming trades, then instantly remove their position. This intra-block liquidity did not result in any significant IL. It was 100% of the profits. Other segments all have a IL/fees ratio greater than 1 which indicates a net loss. This ratio’s upper limit was as high at 1.8. It means that liquidity providers incurred $180 worth of fees in IL to cover $100 of fees. That amounts to a $80 net loss.

“Our core finding is that overall, and for almost all analyzed pools, impermanent loss surpasses the fees earned during this period,”
the study’s authors concluded.

“Importantly, this conclusion appears broadly applicable; we have collected evidence that suggests both inexperienced retail users and sophisticated professionals struggle to turn a profit under this model.”
Find out more about permanent loss.

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