Understanding and Mitigating Impermanent Loss in DeFi: Complete Guide 2024

What is Impermanent Loss?

Impermanent Loss (IL) occurs when the price ratio of tokens in a liquidity pool changes compared to when they were deposited. This phenomenon is unique to automated market makers (AMMs) and can significantly impact liquidity providers' returns.

Mathematical Understanding

The formula for calculating impermanent loss can be expressed as:

IL = 2 * √(P_ratio) / (1 + P_ratio) - 1

where P_ratio = P_new / P_initial

Risk Assessment Framework

• Price volatility analysis
• Correlation between paired assets
• Trading volume and fee generation
• Pool depth and market impact

Mitigation Strategies

Several strategies can be employed to minimize impermanent loss:

• Providing liquidity for correlated pairs
• Using concentrated liquidity positions
• Implementing active management strategies
• Diversifying across multiple pools

Aerodrome's Approach

At Aerodrome Finance, we've implemented several features to help mitigate impermanent loss:

interface ILossProtection {
    function calculateCompensation(
        uint256 initialValue,
        uint256 currentValue,
        uint256 timeInPool
    ) external view returns (uint256 compensation);
}