Understanding Divergence of a Float vault
The Zircon UI will show a special indicator for Float vaults. Besides APR, liquidity and other parameters, Divergence is the most crucial parameter to evaluate your risks and rewards.
Divergence is a percentage that represents your impermanent loss. Positive divergence means positive impermanent loss, negative divergence is negative impermanent loss (hence, impermanent gain).
What does this mean? Let’s say there’s a Float vault with 10% divergence. Alice enters it with 1 ETH, and ETH then goes up by 10%. Alice will be able to receive only 0.99 ETH. While if ETH goes up by 100%, then she’ll receive 0.95 ETH.
What’s happening here? It’s easier to see it by checking her USD value. Let’s say ETH is worth $1000 at first. After a 10% gain, Alice missed on 10% of the gains due to Divergence, so her share is worth $1090. Since 1 ETH is worth $1100 now, her share is worth less in ETH.
If ETH gains 100% in value, Alice’s share is $1900 instead of $2000, which is a 5% total impermanent loss. As the % of gain increases, she’ll bleed more and more ETH.
So far so good, this is similar to other platforms. But what happens if ETH goes down?
If ETH dumps 10% to $900, Alice’s share will be worth $910, or 1.011 ETH. She’s had an impermanent gain, gaining ETH over holding them in the wallet.
But what if divergence is -10%? The outcomes are reversed.
In the 10% gain case, Alice would increase her share to 1.01 ETH, while in the 10% loss case, she’d be reduced to 0.988 ETH.
We lied a little bit before: divergence does indicate whether you’re having impermanent loss or gain, but the percentage itself tells you something different.
In reality, Divergence is defined as the percentage of loss of exposure to the underlying asset.
Option traders will know this as Delta (specifically, divergence is
100% - Delta%).
A positive divergence is bad if you expect the token to go up, but pretty good if you’re trying to hedge from losses. While a negative divergence is great if you expect the token to go up, but it increases your losses if it actually goes down.
Negative divergence is still “impermanent gain” regardless of where the price goes. That’s because it’s a leveraged position, but unlike regular leverage, your position can never go below zero.
As prices go down, Alice would start to reduce her exposure to ETH, eventually reaching positive divergence. While if ETH went up, her exposure would increase and she’d increase her leverage.
Negative divergence happens either when there’s an excess of Stable assets, or when too many Float holders remove their assets (for example by taking profit). It’s a goldilocks zone for the Pylon, and the key for the overall impermanent loss reduction.