What is Impermanent Loss?

Impermanent Loss (IL) is the difference in value between holding tokens in a liquidity pool versus simply holding them in your wallet. When token prices diverge, pool rebalancing can leave you with less value than if you’d just held.

How It Happens

AMM Pool Mechanics

When you provide liquidity:

  1. Deposit equal value of two tokens
  2. Pool rebalances automatically via trades
  3. As prices change, ratio shifts
  4. You end up with more of the cheaper token

Simple Example

Initial deposit:

  • 1 ETH ($3,000) + 3,000 USDC = $6,000 total

If ETH doubles to $6,000:

  • Just holding: 1 ETH + 3,000 USDC = $9,000
  • In pool: ~0.707 ETH + ~$4,243 = ~$8,485
  • Impermanent loss: $515 (5.7%)

Why “Impermanent”?

Called Impermanent Because:

  • If prices return to original ratio, loss disappears
  • Only realized when you withdraw
  • Can recover if prices converge

Becomes Permanent When:

  • You withdraw at unfavorable ratio
  • One token goes to zero
  • You need to exit the position

Impermanent Loss Calculator

IL by Price Change

Price ChangeIL
1.25x (25% up/down)0.6%
1.50x (50% up/down)2.0%
2x (100% up/down)5.7%
3x (200% up/down)13.4%
4x (300% up/down)20.0%
5x (400% up/down)25.5%

IL is the same whether price goes up or down

The Formula

IL = 2 × √(price_ratio) / (1 + price_ratio) - 1

Offsetting IL with Fees

When LP is Profitable

Trading fees earned must exceed IL:

  • High volume pools generate more fees
  • Stable pairs have less IL
  • Fee APY vs IL calculation matters

Example Calculation

  • IL from price change: 5%
  • Fees earned (annualized): 20%
  • Net profit: 15%

Minimizing Impermanent Loss

Strategy 1: Stable Pairs

Pool like USDC/USDT:

  • Minimal price divergence
  • Very low IL
  • Lower fees too

Strategy 2: Correlated Assets

Pool like ETH/stETH:

  • Prices move together
  • Reduced IL risk
  • Still earn fees

Strategy 3: Concentrated Liquidity

On Uniswap V3:

  • Provide in narrow range
  • More capital efficient
  • Higher IL if price leaves range

Strategy 4: Short-Term Provision

  • Monitor positions
  • Exit before major divergence
  • More active management

IL in Different Pools

High IL Risk

  • ETH/Altcoin pairs
  • Volatile new tokens
  • Meme coins
  • Anything vs stablecoins during volatility

Lower IL Risk

  • Stablecoin pairs
  • Correlated assets
  • Large cap tokens

Real-World Considerations

Fees Can Help

  • Trading fees compound
  • May exceed IL
  • Depends on volume

Incentive Rewards

  • Many pools offer token rewards
  • Can offset IL significantly
  • But token rewards may depreciate

Gas Costs

  • Entering/exiting costs gas
  • Factor into calculations
  • Use L2 for smaller positions

Tools for Tracking IL

Calculators

  • Daily DeFi IL Calculator
  • Uniswap Analytics
  • DeFi Llama

What to Monitor

  • Current IL percentage
  • Fees earned to date
  • Net position value

Should You Provide Liquidity?

Consider If:

  • You’d hold both tokens anyway
  • Pool has high volume
  • You understand the risks
  • Time horizon is appropriate

Avoid If:

  • Using money you can’t lose
  • Don’t understand AMMs
  • Expecting large price moves
  • Can’t monitor position

LP on Exchanges

Some centralized exchanges offer liquidity provision:

  • Binance - Liquidity farming
  • Usually simpler interface
  • May have different risk profiles

Summary

Impermanent loss is the cost of providing liquidity. It’s not always bad—fees can outweigh it. But understanding IL is crucial before becoming a liquidity provider.