I recently created an in-depth guide for how to provide liquidity on SushiSwap to take advantage of CCIP-051 which will pay out extra Moons to liquidity providers.

Naturally there were some concerns about Impermanent Loss, the idea of losing money providing liquidity. However the concept isn't fully understood by everyone and doesn't account for how you can actually profit from liquidity if you start with one asset.

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This guide will help you understand how you can make or lose money providing liquidity outside of: trading fees/sushi rewards/CCIP-051 rewards

Example A. Buy into liquidity with ETH and price of Moons go down. (Impermanent Loss)

Example B. Buy into liquidity with ETH and price of Moons go up. (Gain extra ETH)

Example C. Buy into liquidity with Moons and price of Moons go down. (Gain extra Moons)

Example D. Buy into liquidity with Moons and price of Moons go up. (Impermanent Loss)

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Part 1: Buying into Liquidity with ETH

For Example, A and B we will look at buying with ETH: If you are buying into liquidity with ETH, you will be selling your ETH and buying Moons. Once you've done this you'll add an equal value of bought Moons and ETH in the liquidity pool.

• Example A. If the price of Moons go down, your ETH will be sold and you will get even more Moons, this is a form of impermanent loss as the value of your bought Moons are dropping and you are losing even more ETH which gets sold for more Moons. So you are losing money compared to the starting value of your ETH.
• Example B. If the price of Moons go up, your Moons will be sold at a profit and you will be getting more ETH compared to what you paid for your moons. You will end up with more starting ETH as the Moons get sold at a higher price and the value of your liquidity increases relative to what you started with.
  • You can think of this as using ETH to buy Moons and then selling the Moons at a higher price through liquidity.

Part 2: Buying into Liquidity with Moons

This one is essentially the opposite of the first. If you are buying into liquidity with Moons, you are selling your Moons and buying ETH. Once you've done this you'll add an equal value of Moons and Bought ETH into the liquidity pool.

• Example C. If the price of Moons go down the Eth you recieved from selling Moons, will be used to buy Moons back at a lower price. Doing this will end up in a net increase in the amount of Moons you hold (you end up with more Moons compared to what you started with).
  • You can think of this as selling Moons at a higher price and buying them back at a lower price through liquidity.
• Example D. If the price of Moons go up the Moons you put into liquidity will continue to be sold and you will get even more ETH. Because you sold Moons at a lower value, relative to the later increased price of Moons this is another example of impermanent loss - as the total value of your investment dropped since the price of Moons increased after you initially sold them.

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Important: Because the primary trading pool for Moons is currently SushiSwap with a Moon/ETH pairing. The price of ETH changing doesn't really impact the calculations for impermanent loss above.

• If the price of ETH drops and nothing changes for Moons - the price of Moons will drop.
• If the price of ETH increases and nothing changes for Moons - the price of Moons will increase.

Adding Equal amounts of ETH/Moons into liquidity makes it more complicated to understand impermanent loss as you have to account for more variables. However you can run through some hypotheticals using this impermanent loss calculator.

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TLDR:

If the price of moons drop - you could have profited off of liquidity if you sold Moons for ETH and then added the Moons/ETH pair into liquidity.

If the price of moons go up you could have profited off of liquidity if you sold ETH to Moons and then added the Moons/ETH pair into liquidity.

Note: By providing liquidity you become eligible for: Sushi Rewards, Trading Fees, and CCIP-051 Rewards* all of these help decrease the likelihood of a realized loss after accounting for impermanent loss.

^\CCIP-051 payouts are not yet in effect.)