Impermanent loss
Also called: IL · divergence loss
Definition
Impermanent loss is the shortfall a liquidity provider has compared with simply holding the same tokens, caused by the prices of the pooled tokens moving apart after the deposit.
This entry is shown in English.
How Impermanent loss works
In an AMM pool, arbitrage traders rebalance the pool as prices move. If one token rises, the pool sells some of it for the other. When you withdraw, you hold less of the token that went up and more of the one that went down than if you had just held them.
It is called impermanent because the gap shrinks if prices return to where they were when you deposited. If you withdraw while prices have moved, the loss becomes real. Trading fees and rewards can offset it, but not always.
The bigger the price divergence, the bigger the loss. In a standard 50/50 pool, a 2x price change in one token relative to the other costs about 5.7 percent versus holding. Stablecoin pairs and correlated assets usually have far less impermanent loss, while concentrated liquidity positions can suffer more.
Example
Suppose you deposit 1 ETH and 2,000 USDC into a 50/50 pool when ETH is 2,000 USDC, for a total value of 4,000 USDC. ETH doubles to 4,000 USDC. Rebalancing leaves you with about 0.707 ETH and 2,828 USDC, worth about 5,657 USDC. Had you just held, you would have 1 ETH plus 2,000 USDC, worth 6,000 USDC. The difference of about 343 USDC, 5.7 percent, is impermanent loss before fees.
Common mistakes
- Assuming impermanent loss only happens when prices fall.
- Comparing pool returns with zero instead of with simply holding the two tokens.
- Ignoring that concentrated liquidity ranges can magnify the loss.
Learn and practise
FAQ
Can trading fees cover impermanent loss?
Sometimes. If the pool earns enough fees during your deposit period, they can outweigh the loss, but in volatile markets they often do not.
Does impermanent loss happen in stablecoin pools?
Very little while both stablecoins stay at their peg. A depeg of one coin can cause real losses.