Hold ETH or Buy NFTs? Understanding Impermanent NFT Loss

“Media lego” non-fungible tokens have surged in popularity in the Ethereum community this year, and among the NFT economy’s various sectors the digital fine art arena has been an early star.

Why’s that? Because NFTs give artists new programmable revenue avenues, and early innovators have taken notice. NFTs can have royalties automatically caked in, so that whenever a given piece sells in secondary markets, the creator instantly gets a 10% cut or so forth. There’s no traditional parallel to this in the traditional art world, and it’s unquestionably great for creators.

Accordingly, we’ve seen a lot of buzz kick up around the NFT assets ecosystem in recent months, which has brought in lots of new eyes. That’s awesome! But there’s a learning curve and risk involved, just as with all things crypto.

That said, one of my various professional goals is to help newcomers wrap their heads around NFTs shrewdly, like an expert would. So today, with a mind toward approaching risk in this space realistically, I wanted to introduce a concept that clicks as obvious once you think about it, but that I haven’t seen put forth in this way before: Impermanent NFT Loss.

First, What’s Impermanent Loss?

Another one of Ethererum’s major hits this year has been decentralized exchanges, and among the DEX genre automated market makers (AMMs) like Uniswap have been stealing the show lately.

Structurally, AMMs work via liquidity pools. Let’s take a Uniswap trading pool, ETH / DAI, for example. Users can provide liquidity to this pool by depositing equivalent portions of both assets, say 1 ETH and 380 Dai at today’s prices. Liquidity providers receive LP tokens (which can be redeemed for the underlying tokens at any time) and have the potential upside of earning trading fees from folks trading in and out of the ETH / DAI pool.

The risk of providing liquidity to AMMs, then? Impermanent loss, or the acute loss of funds from serving as an LP for a trading pair whose tokens’…

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