Impermanent Loss is not a concern with CAKE staking

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Emmanuel Chibuzor Precious

The biggest challenge liquidity miners face is Impermanent Loss. Staking CAKE takes away this one risk.

Impermanent loss poses a great threat to the high expectations of automated market making. If the expectations can be met, we will see even further decentralization of liquidity provision so that any user with latent capital can safely become a passive market maker.

The threat of Impermanent Loss comes when there is a sizeable change in the price of one or both assets staked by the farmers into a liquidity pool. When it happens, oftentimes the loss outweighs the reward they receive from fees.

When you stake CAKE as an individual asset in any of the eligible pools on pancakeswap.finance, there is no concern about Impermanent loss.

You receive your daily yield according to the advertised APY and whenever you decide to withdraw your asset from the pool, you receive the exact number of the asset you staked, plus your earnings, irrespective of the differences in price of the asset between the time you staked and the time of withdrawal.

So, what actually is Impermanent Loss?

As the name implies, impermanent loss is a temporary loss that liquidity farmers encounter due to divergence in the price of staked assets. It is commonly described as the difference between the returns available simply holding an asset vs those earned when staking such asset in a liquidity pair.

Impermanent loss is possible when a user is stakes two assets in a certain ratio, usually, 50:50. The temporary loss results when one of the staked assets is very volatile in relation to the other.

It is termed temporary loss or impermanent loss because, once the prices of the assets returns to their original price during staking, the loss disappears.

Practical illustration

For a better understanding, let’s use BUSD-BNB pool on Pancakeswap as an example. Assuming you as a liquidity provider enters 50:50 pool; which means you deposit an equal value of BUSD and BNB into BUSD-BNB pool.

Let’s assume price of BUSD is $1 while the price of BNB is $40. 

In the above set up, the starting value of the quantity of both assets is the same.

Now, let’s assume the price of BNB goes up on the external market like Binance to $45. Arbitrage traders see an opportunity to make a quick profit and buy up all the available BNB at the $40 price on PancakeSwap.

The rule for supplying liquidity is that the two supplied assets must maintain a correct ratio of tokens (in this case 50:50) in the pool. As arbitrageurs buy more BNB from the pool, the price of BNB continues to climb.

By the time the price of BNB catches up with the external market, the supplied assets will react to the divergence in the price of BNB. BNB price will be at $45 when there are 559.075 BUSD and 11.11 BNB in the pool. Arbitrageurs would buy 1.39 BNB in order to achieve equilibrium between PancakeSwap and Binance’s BNB prices, costing 59.075 BUSD and achieving an average price of 42.5 BUSD per BNB.

These market movements, and the rules of maintaining a 50:50 ratio in the pool lead to a loss of around $3. You can compare in the table below how much you would have earned if you had simply held 500 BUSD and 12.5 BNB outside of the liquidity pool.

How does this affect liquidity miners?

If the liquidity miner had held his token without supplying to the liquidity pool, he would have had $1062.5 instead of $1059.025. This is not significant due to the low capital we used for this illustration but if a large amount of capital was involved, or the price variance was a lot higher, the effect will be huge.

CAKE Staking: no impermanent loss!

A user that decides to stake CAKE in any of the single asset pools on PancakeSwap has got no reason to worry about Impermanent loss.

Unlike other liquidity pools that require that a liquidity provider supplies two assets at the same ratio, staking CAKE for many of the pools on PancakeSwap involves supplying just a single token — Cake — which is the native token of PancakeSwap.

Since there is only a single token supplied to the pool, divergence in the price of CAKE cannot incur any Impermanent Loss as there is no need to maintain an equilibrium with any other token in the pool.

Irrespective of the difference in the price of CAKE at the time of staking and the time a liquidity provider decides to unstake, the same quantity of CAKE is returned to the liquidity provider when he or she unstakes. This means that a liquidity provider that stakes CAKE receives daily yields according to the annual percentage yield of the pool he or she chooses and also benefit from any upward movement in the price of Cake.

This is an awesome opportunity to earn cool passive income without the fear of Impermanent loss.

How it works

Staking CAKE on PancakeSwap is a simple straightforward procedure. There are different pools on PancakeSwap which gives you as a liquidity provider the opportunity to choose from myriads of rewards. Each pool has its own annual percentage yield boldly specified and the duration of each pool is unique.

Assuming a user decides to stake CAKE on TWT pool, it means that the user will receive his or her yield in TWT which can be harvested at any time.

Processes like staking, harvesting and unstaking incur transaction fees which are settled in BSC BNB. To be able to use these services on Pancakeswap, a user must have BSC BNB in his or her Trust Wallet to settle the transaction fees.

Bottom line

Not even impermanent loss can pose a challenge to earning passive income by staking CAKE on PancakeSwap. Instead of just allowing your latent Cake token lie idle as you wait for price upsurge, staking is an opportunity to earn along the way.

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