Why don’t you make money as an LP?

Many users enter DeFi, excited by the high APY of Liquidity Mining, and invest funds, only to find that after a few months, they not only haven't made money, but their principal has even shrunk.

Why isn't your liquidity staking profitable? Today, we will thoroughly analyze the true reasons why LPs are not making money from five perspectives: Impermanent Loss, fee income, token depreciation, liquidity pool structure, and market manipulation, and provide solutions.

1. Impermanent Loss: LP's Biggest Enemy

What is Impermanent Loss?

When you provide liquidity to an AMM (Automated Market Maker), your funds are deposited in a 50/50 ratio of two tokens (such as ETH/USDC). If the price of one of the tokens fluctuates dramatically, the value of your asset portfolio will be lower than simply holding these two tokens, which is Impermanent Loss.

AMM Calculation Rule (X*Y=k)

Assume the original price of Ethereum is 2000U, if ETH rises to 4000 USDC

• If you don't provide liquidity and simply hold:
  • Your 1 ETH is now worth 4000 USDC, plus the original 1000 USDC.
  • Total value = 4000 + 1000 = 5000 USDC.
• But as an LP, the pool will automatically adjust the price:
  • According to the rule ETH × USDC = 1000, and the new price requires USDC/ETH = 4000, so:
    • Get an equation set X*Y=1000, Y/X=4000
    • New ETH amount = √(100 / 400) = 0.5 ETH
    • New USDC amount = √(100 × 400) = 200 USDC
  • Your liquidity is now worth: 0.5 ETH × 400 + 200 USDC = 400 USDC.

Case Calculation

• You deposit **1 ETH (2000) + 2000USDC** (total value 2000) + 2000USDC** (total value 4000).
• If ETH rises to 4000, your pool will automatically adjust, ultimately becoming 0.707ETH + 2828USDC ≈ 5656.

(According to the AMM automated market-making algorithm. 4000 ≈ 2828/0.7)

• But if you simply hold 1 ETH + 2000 USDC, your total value is $6000.
• Impermanent Loss = 6000−6000−5656 = $344 (about 5.7%)

Conclusion: The larger the price fluctuation, the more severe the Impermanent Loss, which can even consume all fee income.

1. Low Fee Income: LP's Real Income is Overestimated

Many DeFi projects advertise "Ultra-high APY", but the actual income may be far lower than expected, for reasons including:

(1) Insufficient Trading Volume

• If the liquidity pool's trading volume is low, fee income will also be low.
• For example, a pool with a TVL of 10M, with a daily trading volume of only 1M, fees (0.3%) would be only $3000 per day, which becomes minimal when distributed among all LPs.

(2) Mining Token Depreciation

• Many projects incentivize LPs with governance tokens (such as UNI, CAKE), but these tokens may continue to fall.
• For example, a pool showing an APY of 100%, but 80% of which is project tokens, if the token price is halved, the actual return may be only 20%.

1. Token Depreciation: LP's Principal Shrinkage Risk

(1) Staked Tokens Themselves Falling

• If you provide ETH/BTC liquidity, but ETH drops 50%, even with good fee income, your principal will still shrink significantly.
• LP ≠ HODL, during market downturns, LPs may lose more than simply holding.

(2) High Risks of Shit Coin Liquidity Pools

• Many new projects attract LPs with high APY, but tokens may go to zero (like MEME coins, on-chain meme coins).
• For example, a "dog coin copycat" pool with 1000% APY, but the token drops 90% in a week, leaving LPs with nothing.

1. Liquidity Pool Structure Issues: CLMM vs. Traditional AMM

(1) Traditional AMM (like Uniswap V2)

• Funds are uniformly distributed across all price ranges, with higher Impermanent Loss.
• Suitable for stablecoin pairs (like USDC/USDT), but not for high-volatility assets.

(2) Concentrated Liquidity AMM (CLMM, like Uniswap V3)

• LPs can customize price ranges (such as providing liquidity for ETH between 1800-2200).
• Risk: If the price exceeds the range, LP funds will become a single asset, potentially missing out on rises or suffering larger drops.

Example:

• You provide ETH liquidity between 1800-2200, but ETH rises to $2500, all your funds become USDC, missing out on rising gains.

1. Market Manipulation: "Scientists" Targeting LPs

(1) Sandwich Attack

• Robots detect your large transaction, buy ahead to push up the price, making you trade at a higher price, then immediately sell to arbitrage.
• Result: Your transaction slippage increases, and LP income is absorbed by robots.

(2) Liquidity Drain

Large funds suddenly withdraw liquidity, causing insufficient pool depth and dramatic price fluctuations, with LPs bearing additional losses.

Of course, if you want to try issuing tokens and then adding liquidity to understand the entire process, you can choose CPBOX for token issuance, supporting multiple mainnet chains. We also have very detailed guidance articles.

If you want to learn more about CPBOX product's other uses and functions

You can click https://docs.cpbox.io/ to view

Or if you have some good suggestions or development assistance needs

You can find us through the contact information at the bottom of the homepage https://www.cpbox.io/cn/