What is impermanent loss?
In short
Impermanent loss is the amount by which a liquidity pool position underperforms simply holding the same tokens, when their relative price changes.
How can the value of your crypto go up, yet you end up with less money than if you had simply kept it in your wallet? That’s the trap impermanent loss describes.
When you supply two tokens to a liquidity pool, you let other users swap one for the other. In a typical pool with an equal value split, the automated market maker (AMM) adjusts the price based on the available quantities. As trades bring the price in line with the rest of the market, the makeup of your position changes too: you end up with less of the token that’s getting more expensive and more of the other one.
Think of an automated exchange booth with two drawers. When customers take from one and fill the other, your share still corresponds to the same percentage of the drawers, not to the original quantities you put in.
Why it matters
Say you deposit one ETH worth $1,000 and another $1,000 in stablecoins. If the price of ETH doubles, simply holding them would be worth $3,000. In a typical constant-product pool with an equal value split, your position would be worth about $2,828, not counting fees or rewards and assuming the stablecoin’s price holds steady.
So you can be in profit in dollar terms and have impermanent loss at the same time. The comparison is with holding the original tokens, not just with the amount you deposited. The fees you earn may make up the difference, but that’s not a given.
What to watch out for
The word “impermanent” needs care. If the relative price returns to the original ratio, that particular gap can disappear in a typical pool of this kind. But there’s no guarantee it will return, and when you withdraw, you lock in your position’s result.
We think it’s misleading to treat providing liquidity like a deposit with guaranteed interest. Concentrated liquidity can amplify your exposure, and even a pair of stablecoins carries risk if one of them loses its peg. Code bugs and hacks are separate risks, not impermanent loss.