What Is Impermanent Loss?
Impermanent loss is the shortfall between the value of tokens in a liquidity pool and what they’d be worth if you had simply held them. It grows as the price ratio between the pooled tokens changes.
On this page 10
- Why does impermanent loss happen?
- How to calculate impermanent loss: a worked example
- What happens if the price falls?
- Impermanent loss by price change
- Is impermanent loss really temporary?
- Can trading fees offset impermanent loss?
- How do narrow price ranges change things?
- How to reduce impermanent loss
- Frequently asked questions
- Sources
Impermanent loss is the gap between the value of tokens you’ve deposited into a liquidity pool and what those same tokens would be worth if you’d simply kept them in your wallet. It appears whenever the price of the two pooled tokens changes relative to each other, and the bigger the change, the bigger the loss. Direction doesn’t matter: you take a hit whether one token doubles or halves.
Understanding it is the key to knowing whether providing liquidity actually pays. If fees outweigh the impermanent loss, being an LP beats holding; if they don’t, you’d have been better off leaving the tokens in your wallet.
Why does impermanent loss happen?
In automated market maker (AMM) pools like Uniswap’s, the price is set by the ratio of the two tokens. When ETH rises on other markets, ETH in the pool becomes cheap. Arbitrage bots buy that cheap ETH from the pool, paying in USDC, until the pool price matches the market.
As a result, your share of the pool ends up with less of the ETH that went up and more of the USDC that didn’t. In effect, the pool automatically sells ETH for you as the price rises and buys it as the price falls. Someone who just held captures the full upside; the difference is impermanent loss.
How to calculate impermanent loss: a worked example
Suppose you deposit 1 ETH and 2,000 USDC when ETH is $2,000, for a total of $4,000. ETH then climbs to $4,000.
- If you’d held: 1 ETH ($4,000) + 2,000 USDC = $6,000.
- In the pool: under the constant product formula, your share rebalances to about 0.707 ETH and 2,828 USDC, worth roughly $5,657.
- Impermanent loss: $6,000 − $5,657 ≈ $343, or 5.7% versus holding.
Note the denominator. The position is still up about 41% on your original $4,000, so you haven’t “lost money” in the everyday sense. Impermanent loss measures how far you trail the hold scenario, not your result versus your deposit.
What happens if the price falls?
Take the same example, but this time ETH drops to $1,000. Arbitrageurs now add ETH to the pool and take USDC out, leaving your share at about 1.414 ETH and 1,414 USDC, worth roughly $2,828.
Had you held, you’d have 1 ETH ($1,000) plus 2,000 USDC, or $3,000. The gap is again about 5.7%. Whether the price doubles or halves, the percentage loss is the same. On the way down, you also end up holding more of the falling token, which deepens the overall loss.
Impermanent loss by price change
In a standard 50/50 pool, here’s roughly how much you trail holding when one token’s price changes relative to the other (before fees):
- 1.25× change: 0.6%
- 1.5× change: 2.0%
- 2× change (or a halving): 5.7%
- 3× change: 13.4%
- 4× change: 20.0%
- 5× change: 25.5%
These figures come from the formula 2√r / (1 + r) − 1, where r is the price ratio change. The loss is small for modest moves but accelerates quickly for large ones.
Is impermanent loss really temporary?
It’s called “impermanent” because if the price ratio returns to where it was when you deposited, the loss disappears. There’s no guarantee that will happen, though. Withdraw while the ratio is different and the loss becomes permanent. For many LPs, it ends up being a very real loss.
Can trading fees offset impermanent loss?
They can; the question is which is bigger. In the example above, if the position earned more than $343 in fees while ETH climbed, providing liquidity beat holding.
Fee income depends on the pool’s trading volume on the DEX, its fee rate and your share. High-volume pairs whose prices move together tend to work best. Thinly traded pairs with fast-moving small-cap tokens rarely earn enough in fees to cover the loss.
How do narrow price ranges change things?
In concentrated liquidity pools such as Uniswap v3, putting your capital into a narrow price range can earn far more in fees. The same leverage applies to losses, though: the same price move produces much larger impermanent loss than in a full-range classic pool.
If the price exits your range, your position converts entirely into the token that fell (or, on the way up, entirely into the other one) and stops earning fees. A narrow range is an active strategy that needs close monitoring.
How to reduce impermanent loss
- Choose correlated pairs: stablecoin pairs like USDC/USDT, or ETH paired with a liquid staking token, see very little impermanent loss.
- Favor high-volume pools: more fees mean a better chance of covering the loss.
- Use wider ranges: you earn less in fees, but the loss grows more slowly.
- Measure regularly: track pool value, accumulated fees and hold value side by side.
Frequently asked questions
Is there impermanent loss if both tokens rise together?
If both tokens rise or fall by the same percentage, their price ratio doesn’t change and there’s no impermanent loss. It only appears when the tokens move relative to each other.
How is impermanent loss different from an ordinary loss?
An ordinary loss means your position is worth less than you put in. Impermanent loss is a comparison with the hold scenario. That’s why you can be in profit and still have impermanent loss, or be hit by a market drop and impermanent loss at the same time.
Does impermanent loss only happen on DEXs?
It’s specific to AMM pools that price assets by their token ratio. Holding tokens on a centralized exchange or supplying a single token to a lending protocol doesn’t carry this risk.