New Study: Half of Liquidity Providers on Uniswap v3 Are Losing Money

Recent research has shown that impermanent losses have become a growing problem for Uniswap v3 liquidity providers.

A Nov. 17 report by Topaz Blue and Bancor Protocol found that 49.5% of liquidity providers on Uniswap v3 generated negative returns due to impermanent losses (IL).

The report highlights that Uniswap v3 currently generates the highest fees of any automated market maker (AMM), but IL exceeds these earned fees. The study speculates that holding may be a better option for liquidity providers.

“The average Liquidity Provider (LP) in the Uniswap v3 ecosystem is economically harmed by their chosen activities and could be more profitable simply to hold their assets.”

The impermanent loss is a phenomenon that occurs when the liquidity provider of the automatic market maker changes the spot price of the asset it joins the liquidity pool. Since liquidity providers pair two assets together to form a position, when the spot price of the asset changes, the ratio of coins in the position also changes.

For example, if a user provides the USD equivalent of USDT and ETH to a liquidity pool, and the price of ETH rises, arbitrageurs will start removing ETH from the pool and selling it at a higher price. This results in a decrease in the dollar value of the user's position, a so-called impermanent loss.

In this regard, the report makes clear that providing liquidity to Uniswap V3 is inherently risky.

“Users who decide not to provide liquidity can expect to increase the value of their portfolios faster than users who actively manage liquidity positions on Uniswap v3”

During the study period, the pools studied accounted for 43% of the total liquidity in Uniswap v3. From May 5 to September 20, 2021, the pools analyzed generated a total of $199 million in fees from $108.5 billion in trading volume.

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

Of the 17 pools analyzed, impermanent losses in 80% of pools exceeded the fees earned by liquidity providers. Only three (WBTC/USDC, AXS/WETH, FTM/WETH) showed net positive returns. The loss of some capital pools far exceeds 50%, such as MKR/ETH, it is said that 74% of users lose money.

The study also sought to determine whether active and passive strategies produced different outcomes. Active users adjust their positions more frequently than passive users. While the report expected short-term active traders to outperform passive traders, it found no correlation between short-term positions and higher profits.

Among the main time periods analyzed, those who held for more than a month performed best, as almost all users who held for less than a month still had higher impermanent losses than gains.

The report provides a clear conclusion for those considering providing liquidity on Uniswap v3. While it did say a winning strategy could be in place, the expected return could be "comparable to the annual returns offered by mainstream commercial banking products".

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