50% of the liquidity providers for Uniswap V3 are at a loss

Recent research shows that Temporary Losses (IL) are becoming an increasingly serious problem for liquidity providers on Uniswap V3.

According to a report by Topaz Blue and Bancor Protocol released on Wednesday, 49.5% of liquidity providers (LPs) for Uniswap V3 have negative profits due to IL.

report emphasize Uniswap V3 generates the highest fees of any automated market maker (AMM), but the IL is even higher than the fees earned. Research currently recommends hodl as the better choice for liquidity providers.

“The average LP in the Uniswap V3 ecosystem suffers financially due to the way it operates, and it would be more profitable to keep the asset simple.”

A temporary loss is what happens to LPs on AMM when the spot price of the asset they added to the liquidity pool changes. Because liquidity providers combine two assets into one position, the ratio of coins in the position changes when the asset’s spot price changes.

For example, if a user provides USDT and ETH the same value (in USD) to the liquidity pool and the ETH price rises, arbitrageurs will start removing ETH from the pool in order to sell it at a premium. This leads to an impairment in the value of the position, also known as a temporary loss.

In this regard, the report notes that providing liquidity to Uniswap V3 has many inherent risks.

“Users who choose not to provide liquidity can hope to grow portfolio value faster than those who actively manage liquidity positions on Uniswap V3.”

At the time of the study, the analyzed pools accounted for 43% of the total liquidity of Uniswap V3. In total, they generated $ 199 million in fees between May 5 and September 20, 2021 through a trading volume of $ 108.5 billion.

During that period, these pools suffered $ 260 million in IL, resulting in a total net loss of $ 60 million.

Of the 17 pools analyzed, 80% had higher ILs than the fees charged by the liquidity providers. Only 3 pools WBTC / USDC, AXS / WETH and FTM / WETH have a positive net profit. Some pools lose more than 50% such as MKR / ETH with 74% of users reporting losses.

Fees and Temporary Losses | Source: Topaz Blue and Bancor Protocol

The study also attempted to determine whether an active strategy produces different results than a passive strategy. Active users adjust their position more often than passive users. Although the report predicts that active short-term traders will outperform passive traders, no correlation can be found between short-term positions and higher returns.

Of the time segments analyzed, owners of more than a month did the best, as practically all time frames under a month still have higher ILs than earnings.

IL / fee ratio by operating time | Source: Topaz Blue and Bancor Protocol

The flash liquidity providers are the only group that has not suffered significant temporary losses.

The report gives a clear conclusion to users considering offering liquidity on Uniswap V3. While there may be strategies to help players “win big”, the expected returns are “in line with the annual interest rates of mainstream commercial banking products”.

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