Analysis: Is Providing Liquidity to Uniswap Profitable?

My name is Karl Diab, the developer behind myuniswapbuddy.com. I created My Uniswap Buddy to better understand the viability of becoming a liquidity provider for Uniswap. I’ve discovered providing liquidity is generally a very profitable for large market cap cryptocurrency and stable coin pair pools. The story is not the same for providing liquidity for stable coin to Ethereum or small market cap currency pools, which have mostly performed poorly.

As you may know, Uniswap is a decentralized finance (DeFi) cryptocurrency exchange that exists on the Ethereum blockchain. Anyone can use Uniswap without the need to create an account or submit any AML/KYC documents. There are two types of users: traders and providers. Traders swap tokens on the platform for a fee of 0.3%. Providers loan Uniswap liquidity in the form of cryptocurrencies pairs in equal values for both tokens. This token pair on Uniswap is called a liquidity pool, or simply pool. For example Ethereum and Wrapped Bitcoin (a tokenized version of Bitcoin enabled to be used on the Ethereum blockchain) is currently the largest pool on Uniswap in terms of value of liquidity. Providers are rewarded by receiving a portion of the trading fees collected by the pool, their share of the exchange fees is proportional to the amount of liquidity they’ve provided.

That sounds excellent for providers, but there is a big gotcha: providers are not guaranteed returns, in fact they can lose money due to a factor called impermanent loss. I won’t go into detail on impermanent loss as there are a number of well written articles that do just this. The most important thing to note is as the price ratio of the coin pair changes in either direction, the impermanent loss increases. As a rule of thumb, if the price doubles in either direction, a provider’s impermanent loss will be 5.7%. This means the provider’s investment will be worth 5.7% less than if they had simply just held the coins, ignoring any exchange fees collected. However, it is called impermanent loss because if the price ratio goes back to its original value, impermanent loss will return 0, assuming the provider had not closed their position.

Exchange fees, however, are always a positive, ever-increasing number. The more trading volume the pool receives, the higher the exchange fees.

A provider’s profitability, compared to if they had held the coins instead, (often called difference of HODL or net ROI) is the exchange fees collected minus the impermanent losses. The question is, how likely is it that the exchange fees will be larger than the impermanent loss? Lets take a look!

We’ll explore four different types of liquidity pools: Large market cap crypto/Ethereum, stable coin/Ethereum, stable coin/stable coin, and small market cap crypto/Ethereum.

Profitability of Large Market Cap Crypto Liquidity Pools

Historically, these have performed excellently. When I say large cap crypto, think Bitcoin, Ethereum, Chainlink, Uniswap token, and Maker. Typically, the prices of these coins move in step with Ethereum, at least well enough for the exchange fees to outpace impermanent losses.

All profitability is displayed in annual percentage rate (APR), meaning the return on investment has been extrapolated to a full year. For example, if your investment has appreciated by 0.49% over 30 days, this is an APR of 6.12%. If you would like to see the raw ROI not extrapolated to APR, you can go to the pool analyses linked below on My Uniswap Buddy and click on the “View as Absolute Percent” button.

Wrapped Bitcoin/Ethereum (WBTC/ETH) pool

Looking at the analysis, we can see providing liquidity to this pool at almost anytime would have been quite profitable.

The table on the right shows the APR you would have earned if you provided liquidity 7, 30, 90, or 180 days ago or the day the pool was created, 317 days ago in the picture. If you had provided liquidity 317 days ago, you would have earned a 14.08% APR on your investment. If you provided 180 days ago, 11.82% APR, 90 days, 9.97% APR, etc.

The graph on the left shows the same data as the table, but your profitability if you had provided liquidity on any given day. We can see your profitability would have been negative if you provided very recently as there has been a recent price shift and exchange fees haven’t been given much time to accrue.

When you view the analysis, the values will all be different. This is because the profitability shifts based on ever shifting market conditions.

View the WBTC/ETH pool here

Chainlink/Ethereum (LINK/ETH) pool

This pool has been even more profitable than the WBTC/ETH pool despite having much larger price shifts. This is because the trading volume has been higher proportionally to pool liquidity which more than makes up for the higher impermanent losses.

View the LINK/ETH pool here

Uniswap/Ethereum (UNI/ETH) pool

This pool is the exception to the big crypto pools, you would have lost money if you had provided liquidity anytime during most of the existence of the pool.

We can see why when using the “Prices” view on the graph. The price of UNI against ETH tripled between January and April 2021 making the impermanent losses vastly outpace exchange fees. People who provided liquidity sometime in Nov 2020 to Jan 2021 will eventually make up for this loss with exchange fees if the price remains stable, or make a hefty profit if the price of UNI falls back to its original level. Of course the losses can deepen if UNI continues to rise against ETH.

View the UNI/ETH pool here

Maker/Ethereum (MKR/ETH) pool

The MKR/ETH pool is another poster child of the high profitability large crypto pools. It has shown relative price stability and high trading fees.

View the MKR/ETH pool here

Profitability of Stable Coin to Ethereum Liquidity Pools

USD Coin/Ethereum (USDC/ETH) pool

The picture isn’t so pretty with stable coin to Ethereum pools. As you can see, providing liquidity anytime except for very recently would of resulted in a negative ROI. This is because of the recent crypto bull run that has sent the price of Ethereum soaring way above stable coins.

As you can see here, the price of USDC, which is pegged to the US dollar has plummeted against Ethereum resulting in substantial impermanent loss.

However, these losses could be considered a good thing. If an investor wanted to realize gains whenever the price of ETH goes up. As the price of ETH against USDC rises, so do impermanent losses, but that also means a provider’s ratio of USDC to ETH in their position increases. This could be considered selling a small amount of ETH whenever the price rises, or buying more ETH when the price falls, while collecting exchange fees the whole time. I’ll explain this method of investment hedging in more detail in a future article.

View the USDC/ETH pool here

Profitability of Stable Coin Only Liquidity Pools

DAI/USD Coin (DAI/USDC) pool

Stable coin only pools are very interesting because there is virtually no impermanent loss as both coins are pegged to the US dollar. If you have a stash of stable coins, this is one of the least risky methods to gain interest on them. Of course, there is always the risk of Uniswap being exploited, but Uniswap has been heavily audited and is well regarded. That same risk exists with any centralized finance company offering interest in addition to the risk of an exit scam or regulatory crackdown, at least Uniswap is immune to the latter two risks. The biggest risk, in my opinion, is if the value of either stable coin collapses, you impermanent loss will be 100%. So choose your trusted stable coins wisely!

View the DAI/USDC pool here

Profitability of Small Market Cap Crypto Liquidity Pools

I generally do not recommend providing liquidity to these pools, as the prices of small cap coins are highly volatile making the impermanent losses massive. However, there have been many smaller pools that have been extremely profitable, as we will see.

DraftCoin/Ethereum (DFT/ETH) pool

This seems to be the typical picture for small coin pools. The high price volatility causes the impermanent losses to overshadow trading fees.

As you can see here, the price of DFT has increased and decreased in orders of magnitude which drove the massive impermanent losses.

View the DFT/ETH pool here

Phala Network/Ethereum (PHA/ETH) pool

This is one of the many huge wins for small coin pools, yielding providers with an APR of up to 264%!

Looking at the “Volume” view of the PHA/ETH pool graph, we can see the pool has had massive trading volume compared to its liquidity. On January 1, 2021, the pool traded over 1,500% of its liquidity. This means all PHA/ETH providers earned 15 x 0.3% = 1.5% in exchange fees, just on that day alone! This is the big advantage to small coin pools.

View the PHA/ETH pool here

Conclusion

Looking at past performance, providing liquidity to large market cap currency and stable coin only pools to be a safe and profitable investment. The exchange fees earned from these pools almost always outpaces impermanent losses.

Stable coin to Ethereum pools have all been unprofitable due to cryptocurrency’s recent massive bull market. However, providing liquidity to stable coin to crypto pools can still be a wise move if an investor wants to automatically sell crypto when the price goes up and buy more when the opposite happens.

Stable coin only pools are quite profitable with almost no risk of impermanent loss. A great choice for users with reserves of stable coins wanting to earn relatively low risk interest.

Small market cap coin pools are usually very unprofitable, but many have performed phenomenally due to massive trading volume against their small liquidity reserves; higher risk, higher reward.

Don’t take my word for it, view the pools list here and make your own conclusions!

Software developer from Vancouver with an affinity for cryptocurrency and DeFi. My latest projects include myuniswapbuddy.com and mycryptobuddy.com