Bancor is updating its protocol once more to defeat the insidious issue of impermanent loss, which it earlier called “DeFi’s dirty little secret.”
Impermanent loss, also called divergence loss, affects exchanges based on automated market makers like Bancor or Uniswap. It happens when the prices of two assets in a liquidity pool diverge significantly, with one side going strongly up or down in value.
The effect translates to a loss of value compared to a benchmark “buy and hold” portfolio. Liquidity providers (LP) may take out less money than they would have had if they just held the tokens separately — despite the fact that they earn trading fees from the protocols.
The issue occurs because of arbitrage traders, who are necessary for AMMs to bring their prices in line with the other markets. Their activity nevertheless extracts value from LPs who facilitate the exchange.
The loss was initially called “impermanent” because if the prices return to their initial state,