Weighted variance swaps hedge against Impermanent Loss

24 Pages Posted: 3 May 2022

See all articles by Masaaki Fukasawa

Masaaki Fukasawa

Osaka University

Basile Maire

Desma Eight, LLC; Quantena

Marcus Wunsch

ZHAW School of Management and Law

Date Written: April 27, 2022

Abstract

Impermanent Loss, the discrepancy between the payoff of liquidity provision versus buy and hold, is sometimes referred to as the ’silent killer’ in Decentralized Finance. We describe how Impermanent Loss can be hedged in a Constant Function Market, both statically as well as dynamically. If the market is complete, the cost of this hedge constitutes the rational price of providing liquidity. We demonstrate that the appropriate hedging instrument against Impermanent Loss in a Constant Product Market lies between variance swaps and gamma swaps, and describe the class of Constant Function Markets whose Impermanent Loss can be hedged with weighted variance swaps.

Keywords: Digital currencies, impermanent loss, decentralized exchanges, weighted variance swaps

JEL Classification: D47, C02

Suggested Citation

Fukasawa, Masaaki and Maire, Basile and Wunsch, Marcus, Weighted variance swaps hedge against Impermanent Loss (April 27, 2022). Available at SSRN: https://ssrn.com/abstract=4095029 or http://dx.doi.org/10.2139/ssrn.4095029

Masaaki Fukasawa

Osaka University

1-1 Yamadaoka
Suita
Osaka, 565-0871
Japan

Basile Maire

Desma Eight, LLC ( email )

435 W 31st St
New York, NY 10001
United States

HOME PAGE: http://www.desma8.io

Quantena ( email )

Gotthardstrasse 26
Zug, 6300
Switzerland

Marcus Wunsch (Contact Author)

ZHAW School of Management and Law ( email )

Technoparkstrasse 2
Winterthur, 8400
Switzerland

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