Half of all users who provide liquidity on the third version of the decentralized exchange Uniswap are seeing lower returns than they would have if they simply held tokens in their own wallet, a new study claims.
According to the study, the negative returns for users are due to the trading fee income generated by the protocols being smaller than the so-called impermanent losses, or losses that are incurred when your funds are still in a liquidity pool, as a result of how automated market makers (AMMs) like Uniswap work.
“While Uniswap V3 generates the highest trading fees of any DeFi protocol, impermanent loss entirely wiped out fee income in over 80% of the pools analyzed,” the study, conducted by crypto advisory firm Topaze Blue and the decentralized liquidity protocol Bancor (BNT), said.
It added that the liquidity pools analyzed in the study – which constituted 43% of Uniswap V3’s total value locked (TVL) – generated USD 108.5bn in trading volumes and USD 199m in trading fee income between May 5 and September 20 this year. Still, the income was not enough to make up for losses.
“However, during the same period, the pools incurred over USD 260m in impermanent loss, leaving 49.5% of [liquidity providers] with negative returns,” the team behind the study wrote.
Liquidity pools made up of stablecoins-to-stablecoins such as USDT/USDC, and different versions of the same cryptocurrency such as renBTC/WBTC, which are less prone to impermanent losses, were excluded from the study.
Meanwhile, the study also found that some liquidity pools had an even higher percentage of users that were losing money, with for instance the maker (MKR)/ethereum (ETH) pool giving negative returns to 74% of the liquidity providers.
For other pools, such as the USDC/ETH and COMP/ETH pools, returns were negative compared to just “HODLing” for around 60% of the users providing liquidity, the team behind the study said.
Lastly, the study noted that the only group that “consistently made money when compared to simply HODLing” were so-called “just-in-time” liquidity providers. These are users who will provide liquidity for a single block in order to collect fees from upcoming trades, and then instantly remove the liquidity again afterward.
Given that this liquidity is provided “intra-block,” it did not incur any meaningful impermanent loss, and could collect 100% of the trading fees as profits, the report said, concluding:
“[…] overall, and for almost all analyzed pools, impermanent loss surpasses the fees earned during this period,” and “both inexperienced retail users and sophisticated professionals struggle to turn a profit under this model.”