What Is Impermanent Loss?
Impermanent loss is the phenomenon where the outcome of providing liquidity to a pool lags behind the result of simply holding the same assets in a wallet.
On this page
- Why Does the Amount of Assets in the Pool Change?
- A Simple Example with Numbers
- Why Does the Denominator for Percentage Calculations Matter?
- Does the Word “Impermanent” Mean Losses Will Be Reversed?
- Can Trading Fees Close the Gap?
- How Does the Situation Change in Narrow Price Ranges?
- Three Separate Metrics for Monitoring Your Position
- What Happens if Both Assets Rise Together?
- Sources
Impermanent loss is when the value of the assets you deposit into a liquidity pool lags behind the value you would have reached if you had simply held those same assets in your wallet. In Turkish, it is referred to as “geçici kayıp.” The comparison here is not between your initial investment and today’s money, but between being in the pool and holding the assets as they are. Therefore, impermanent loss can be seen even in a position that is in profit in dollar terms.
Why Does the Amount of Assets in the Pool Change?
In Automated Market Maker (AMM) pools, swaps change the ratio of assets in the pool. When the market price of ETH rises, traders and arbitrageurs may take ETH from the pool and leave the other asset in exchange. Arbitrage is the process of profiting from price differences across different markets. While these transactions bring the pool price closer to the external market, they can reduce the amount of ETH held by the liquidity provider.
From the provider’s perspective, this situation is similar to selling a portion of the rising asset throughout its price movement. If the price falls, the opposite change may occur. The result depends on the pool’s pricing formula and the selected price range. It is not accurate to use the same loss table for every pool. In particular, concentrated liquidity positions can produce different results compared to classic pools spread across the entire price range.
A Simple Example with Numbers
Let’s imagine a hypothetical ETH/USDC pool that keeps the product of two assets constant, with no fees or expenses. Initially, let the price of 1 ETH be $2,000. If you have a share in the pool worth 1 ETH and 2,000 USDC, the initial total is $4,000. Holding the same assets in your wallet is your alternative. We assume that USDC stays exactly at $1 throughout this example.
When the ETH price rises to $4,000, the basket held in the wallet is worth $6,000: $4,000 for 1 ETH and 2,000 USDC. In the simplified pool model, your share turns into approximately 0.7071 ETH and 2,828.43 USDC. Their total value is approximately $5,656.85. You are in profit compared to the $4,000 you initially invested; however, you are approximately $343.15 behind compared to the holding option.
| Comparison | Value |
|---|---|
| Initial deposited basket | $4,000 |
| Holding in wallet when ETH doubles | $6,000 |
| Pool share at the same time, excluding fees | $5,656.85 |
| Difference compared to holding | −$343.15, approx. −5.72% |
Why Does the Denominator for Percentage Calculations Matter?
The 5.72% above is found by dividing the loss by the $6,000 holding value. Dividing by the initial capital of $4,000 produces a different comparison. Do not compare percentages without understanding which amount is being used as the base in impermanent loss calculators. Similarly, the decrease in the amount of the asset you deposited is not the total loss by itself; the amount of the other asset may have increased.
For a classic pool of two assets with equal value, the comparative change excluding fees can be shown with the formula 2 × √r / (1 + r) − 1, where r is the price ratio. When the price doubles, r = 2. The meaning of the formula is to compare the ratio of the pool value to the holding value. This formula should not be directly applied to single-sided positions, pools with different weights, or limited price ranges.
Does the Word “Impermanent” Mean Losses Will Be Reversed?
The name comes from the fact that this comparative difference can disappear in the classic model if the price ratio returns to its starting level. It does not promise that the price will actually return. If you close the position at different ratios, you take the asset distribution as it is at that moment. A subsequent return of the price to its old level does not automatically change the result of a closed position.
Furthermore, if a token permanently loses value, continuing to hold it in a pool may not solve the problem. An example of this is when a stablecoin deviates from its value (depegging). The pool may fill up with the increasingly weakening asset. Viewing impermanent loss merely as an on-screen figure that will fix itself just by waiting misses the reality of what assets the position has actually converted into.
Can Trading Fees Close the Gap?
Because liquidity providers can earn fees from swaps, the final result does not depend solely on price changes. In the example, we calculated that the pool share was $5,656.85. If $400 in net fee income were added to this, the total would be $6,056.85, exceeding the $6,000 holding option. However, if the fee income stays at $100, the total would be $5,756.85; the gap would not be closed.
These numbers are chosen to demonstrate the mechanism, not as an expected return. Volume, fee tiers, protocol cuts, and active liquidity share vary. If reward tokens are being distributed, their sale value should also be taken into account. Gross rates shown without deducting network fees, the cost of opening/closing positions, and range adjustment costs do not tell the real net result.
How Does the Situation Change in Narrow Price Ranges?
In concentrated liquidity, capital works within a specific range. This can offer the opportunity to obtain a higher fee share with the same amount; however, once the price moves out of the range, it is possible for the position to convert into a single asset and stop producing fees. The 5.72% example given for a classic pool cannot be used to predict the loss in a position where a narrow range has been selected.
Constantly rebalancing the range does not magically erase the difference either. It may be necessary to swap assets while repositioning, and your current result becomes your new starting point. When using a calculator, enter the pool version, lower and upper prices, deposited amounts, and fees correctly. A single annual percentage yield (APY) does not show how the portfolio will change under different price scenarios.
Three Separate Metrics for Monitoring Your Position
The first is the current total value of the initial investment, the second is the current value of holding the same assets, and the third is the net value that can be withdrawn from the pool including fees. Writing these three numbers side-by-side separates the loss caused by a market downturn from the additional effect of being in a pool. Use the same currency and the same price timestamp for all values. This way, instead of just saying “I’m in profit” or “I’m at a loss,” you can see where the result is coming from.
What Happens if Both Assets Rise Together?
The fundamental element creating impermanent loss is the price change of assets relative to each other in a classic two-asset pool. If the dollar prices of both rise at the same rate, the ratio between them may remain constant; in this case, no comparative loss arises from the shared dollar increase alone. If one doubles while the other stays constant, the ratio changes. Therefore, do not directly apply the result of the ETH/USDC example to a pool containing ETH and another volatile asset. Use the relative price of the two assets in the calculation alongside the dollar prices; the fee and pool model must still be evaluated separately.