All Liquidity Pools (LP) are exposed to Impermanent Loss (IL), when the price ratio of the two assets in the pool diverges. This has been discussed in a previous lesson on IL. In many LP protocols, the hope is that yield/earnings from the LP will be greater than the IL, thus returning a profit back to the depositor. But let’s see the THORChain case.
What’s specific with THORChain?
In THORChain’s design, there is another incentive for LP called Impermanent Loss Protection (ILP). First of all, ILP is based on the 50:50 symmetrical deposit of both assets. If the user chose to deposit asymmetrically instead, ILP calculation will be based on AFTER the initial 50% swap.
After 100 days in the LP, when the user withdraws, if the IL is greater than the earnings from yield/rewards, this means that the user’s LP value overall is worse off compared to just holding both assets (the deposit quantity) in their wallet and not participating in the LP. In this case, the ILP will kick in and reimburse the differential amount, and ensure that users will at least withdraw the same total value as per the assets provided in the initial deposit, at the current day’s market value.
Note that since prices have changed, the actual quantity of both tokens during withdrawal may be different vs the deposit; but users can always then swap one for the other and obtain the exact same deposited amount of asset.
If a user withdraws before 100 days, then the eligibility for ILP is prorated: e.g. 42% protection on day 42, etc. Finally, if users top-up their LP upon an existing position, the ILP timer counter will be reset back to day for the position.