Animal Farm: Ephemeral Loss. What You MUST Know Before Running Yield Farm! | by CryptoTechJester aka MarcB

Impermanent Loss (IL) is a yield farming issue that every yield farming investor needs to know and consider. What is it and how concerned should you be about it? We will examine it in this article.

First the most important question:

Should I even worry about a temporary loss? I mean what effect does it have on me?

Answer: Yes, you have to take care of it. However, you may not need to worry about that. It will affect you as there will be an overall loss of your position even if you are yield farming.

To understand transitory loss, we need to discuss the difference between the price movements of common coins.

Stablecoins like BUSD, USDC, and USDT do not (generally) fluctuate in price. Or if they do, it’s only a tiny part, and in most cases they recover completely. They are usually designed to be pegged (or matched) to a fiat currency. In this case the US dollar. There are other stablecoins, but all stablecoins in Animal Farm are pegged to the US dollar.

Blue-chip cryptocurrencies like Bitcoin, Ethereum, and BNB tend to collectively follow market fluctuations. In general, although not exactly, Bitcoin, Ethereum, and BNB should move strongly relative to BUSD, but NOT strongly relative to each other. Most often they move in proportion to each other. Compare these three charts.

Bitcoin 1 year chartEthereum 1 year chartBNB, 1 year chart

The three coins do not show any major price movements relative to each other. Now compare these charts to some other cryptocurrencies with related farms on Animal Farm:

DOT 1-Year Chart (Polkadot)LINK 1-year chart (Chainlink)CAKE 1 year chart

This next category of coins are not premium cryptos, but rather small market cap cryptos and those that don’t always move the same compared to bitcoin etc. They show fundamental movement until the market downturn in May and June. but have some unique shapes afterwards.

It is important to know the basic coin designs. You cannot predict the daily markets, but you can predict if the coins will move relative to each other.

So what is a temporary loss?

Transient is the depreciation over time caused by the value of two coins in an LP token differing in relative value. I will illustrate the effects with some examples:

Ex. 1. Simplified holding of two crypto coins individually. 250 BUSD coins and 1 BNB coin. Let’s assume that both have the same value today. In other words: 250 BUSD = 1 BNB. You start with a value of $500 (250 BUSD + 1 BNB worth $250). Now let’s say the value of the BNB doubles to $500 per 1 BNB. You are now worth $750 (250 BUSD + 1 BNB worth $500). Because you kept these coins separate and did NOT create an LP token, there is no temporary loss and no loss in value.

Ex. 2. You pair 250 BUSD with 1 BNB. At the time of mating, they are worth the same. So now you create an LP token with BUSD/BNB LPs totaling $500. Now, when the value of BNB increases to $500, the LP becomes unbalanced. And LPs MUST be balanced. So, to maintain balance, some BNB needs to be removed as its value increases, and BUSD needs to be added. And in the process, some of the value is lost. If BNB is worth $500, your LP token now has 353.55 BUSD and 0.705 BNB. Because of the required balance, you are now worth $707.1 ($353.55 from BUSD and $353.55 from BNB). Your “hold value” of the two coins would have been $750 and your LP value is worth $707.1, so you have a loss of $42.9 compared to if you just held them. This is your fleeting loss.

Ex. 3 You combine $250 worth of ETH with $250 worth of BTC and create an LP token from a total of $500 worth of ETH/BTC LPs. After some time both double in price. Now you have $500 worth of ETH in your LP and $500 worth of BTC in your LP, with a value of $1000. Since they didn’t need to be rebalanced and both increased in equal proportion, there’s no loss. There is no fleeting loss.

Comparing examples 1 and 2 shows the dangers of creating LP tokens, especially when using a stablecoin as ONE of the input coins but a non-stablecoin as the OTHER of the input coins. The LP pair needs to stay balanced, and that leads to a loss in value compared to just holding it.

However, pairing two top-tier cryptocurrencies that often move in the same ratio can usually cause little to no temporary losses.

When participating in yield farming, you take two coins and combine them into a pair, creating LP tokens. Your LP tokens are then deposited into a Mission Contract where they earn Reward Tokens. In the case of Animal Farm, you earn DOGS.

Before going into the details of farming with fleeting losses and gains, I will present the conclusions. Then I will announce more details. But once you know where I’m going, the details will make more sense.

1. If you’re a long-term investor in the animal farm and plan to make LOTS of DOGS and PIGS over a long period of time (say, more than a year), you probably don’t have to worry too much about temporary losses.
2. If your LP tokens are paired blue-chip cryptos like ETH and BTCB or BNB and BTCB, you probably don’t have to worry too much about a temporary loss.
3. If your LP tokens are a blue-chip cryptocurrency (ETH, BTCB, BNB) or a small-cap cryptocurrency paired with a stablecoin (BUSD, USDC, etc.) and you don’t plan on using your cryptocurrency at least one Year after year you may have to worry about temporary losses.
4. If your LP tokens contain a stablecoin and a non-stablecoin AND the market moves a lot during your yield farming, you may have to worry about temporary losses.

Let’s take a closer look at each of these scenarios. Remember it A temporary loss is the loss in value caused by the realignment of equal sides of an LP token.

1. The longer you stay on the farm, the more rewards you get. If you suffer a temporary loss of $300 but your rewards total $500 over the same period, you have a profit of $200. In general, the longer you stay on a yield farm, the more the rewards outweigh the temporary loss.
2. When two blue-chip cryptos are paired together, the temporary loss is greatly reduced, so there is no need to worry about it at all.
3. If you’re pairing a non-stablecoin with a stablecoin and don’t plan on keeping the LP in the farm long enough for the rewards to exceed the transient loss, you may want to look for another LP token with minimal transient loss.
4. When you pair an unstable currency with a stable currency and the market moves a lot, you will experience large temporary losses and you may want to avoid this yield farm. Let me give you an example here. Let’s say you formed a pair when ETH is $1,500 and ETH surges to $8,000 in a bull market. And you originally staked $500 BUSD and $500 ETH, so the value was $1,000. After the price of ETH surged from $1,500 to $8,000, your LP tokens are now worth $2,309.40 (find the fleeting loss calculator on DailyDefi.org). If you just kept ETH and BUSD separately, you would have $3166.67 ($500 worth of BUSD and $2666.67 worth of ETH). In that time, you would have had to earn $857.27 worth of reward tokens to make this yield farm worthwhile.

Let’s keep it simple. Here’s what I would do.

Of course I’m now saying what I would do and this is not to be construed as financial advice. That being said, here are some rules I follow:

Rules for avoiding negative effects of a temporary loss

1. When approaching a bull market, don’t use half stablecoin pairs. Instead, use top-tier cryptos for both sides. In other words, favor ETH/BTC over ETH/BUSD. This allows you to benefit from the price increases in ETH and BTC in the bull market while avoiding temporary losses.
2. When approaching a bear market, don’t use half stablecoin pairs. Instead, use stablecoins for both sides. Favor BUSD/USDC over ETH/BUSD. This allows you to completely avoid the negative effects of the bear market price decline while completely avoiding temporary losses.

Wait, when can I use ETH/BUSD LP tokens (or others that have only one side of stablecoin)?

Answer: Only in a sideways market! If the coins don’t fluctuate, you don’t have to worry about a temporary loss!

Make it EVEN EASIER!

Here is a chart:

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