Arbitrum Blockchain Traders Can Now Protect Against 'Impermanent Loss'

Decentralized trading service GammaSwap today launched on the Arbitrum network in a move developers say could benefit liquidity providers on the popular blockchain by offering a way of protecting against what's known as impermanent loss.

GammaSwap allows decentralized finance (DeFi) users to borrow liquidity provider (LP) tokens from automated market makers (AMMs) and “short” them, hedging against supplied collateral or creating low-risk trading strategies. Shorting is a strategy for profiting from a drop in the price of an asset.

Automated market makers are blockchain-based trading mechanisms that group assets together in a so-called pool and fix a trading ratio based on the balance between supply and demand. A liquidity provider – someone who provides an asset to the pool in exchange for a reward – takes on the risk that the ratio will change, resulting in an impermanent loss (IL).

Impermanent loss occurs when the pool rebalances. As the prices of the tokens in the pool diverge from their starting ratio, the liquidity provider position loses value. The higher the volatility, i.e. the more the ratio between the prices of the tokens diverges, the more the LP loses and the more likely they are to have negative returns. The loss is impermanent because it's erased if the ratio returns to the starting position.

Since market volatility and LP profits are inversely related, the liquidity providers are essentially “shorting” volatility, that is they profit when volatility is low and lose money when volatility is high. That's what GammaSwap is looking to tackle.

GammaSwap allows traders to “go long” volatility, rather than shorting it, by effectively “shorting” LP tokens. It allows them to take the opposite position to a liquidity provider and create an impermanent gain rather than an impermanent loss.

These features could help encourage more users to become liquidity providers as it allows them to hedge against falling token prices, and should therefore increase liquidity across Arbitrum.

A GammaSwap representative told CoinDesk that the team plans to deploy on more blockchains, such as BNB Chain and Ethereum, and provide support for Uniswap LPs – which lock billions of dollars worth of tokens across thousands of trading pairs.

UPDATE (Sept. 20, 14:12 UTC): Adds mechanism of GammaSwap strategy in fifth paragraph, use in seventh.