What Is Impermanent Loss?
Definition
Impermanent loss is the difference in value between holding tokens in a liquidity pool versus simply holding them in your wallet, caused by price divergence between the paired assets.
When you provide liquidity to an AMM pool, the protocol automatically rebalances your position as prices change. If one token in the pair increases in value relative to the other, the AMM sells some of the appreciating token and buys more of the depreciating one to maintain the constant product formula.
The result: if prices diverge significantly from when you deposited, you end up with less total value than if you had simply held both tokens. This difference is called "impermanent loss" because it only becomes permanent when you withdraw your liquidity.
- It's called "impermanent" because if prices return to your entry ratio, the loss disappears
- Trading fees offset the loss — high-volume pools may earn enough fees to more than compensate
- The larger the price divergence, the greater the loss — a 2x price change results in ~5.7% impermanent loss
- Stablecoin pairs (USDC/USDT) have minimal impermanent loss since prices stay close
Understanding impermanent loss is essential before providing liquidity. For new token launches, the initial price is set by you (the LP), so impermanent loss begins from whatever ratio you choose.
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