Impermanent Loss
Definition
The potential loss liquidity providers experience when the price ratio of tokens in their pool changes compared to simply holding the tokens outside the pool.
Impermanent loss (IL) is the most misunderstood risk in DeFi liquidity provision. It occurs because AMMs rebalance your token holdings as prices change. When one token in your pool appreciates significantly, the AMM automatically sells some of it and buys more of the other token to maintain the pool ratio. You end up with more of the depreciating token and less of the appreciating one.
The math: if you provide equal values of ETH and USDC to a pool and ETH doubles in price, impermanent loss is approximately 5.7%. If ETH triples, IL is about 13.4%. The loss compared to simply holding both tokens grows as the price divergence increases.
The loss is called "impermanent" because if prices return to their original ratio, the loss disappears. However, if you withdraw while prices are divergent, the loss becomes permanent. In practice, many LPs experience permanent losses because crypto prices rarely return to exact starting ratios.
Whether providing liquidity is profitable depends on whether trading fees exceed impermanent loss. In high-volume pools with moderate price changes, fees can more than compensate for IL. In low-volume pools with volatile tokens, IL often exceeds fee income.
Strategies to mitigate IL include: providing liquidity for stablecoin pairs (minimal IL since prices stay close), choosing correlated pairs (ETH/stETH), using single-sided liquidity protocols, concentrating liquidity in narrow ranges (higher fees per dollar), and using IL insurance products offered by some protocols.
Where this appears in Clarity
Clarity automatically tracks and calculates these concepts across your connected accounts.
Related Terms
Frequently Asked Questions
Can I avoid impermanent loss?
You can minimize it by providing liquidity to stablecoin pairs (USDC/USDT has near-zero IL), correlated pairs (ETH/stETH), or using single-sided staking protocols. You cannot eliminate IL in standard two-token pools with volatile assets — it's an inherent tradeoff of AMM mechanics.
Is impermanent loss worth the fees earned?
It depends on the specific pool. High-volume pools on major tokens (ETH/USDC on Uniswap) often generate enough fees to offset IL. Low-volume altcoin pools rarely do. Calculate your total return including fees, IL, and any incentive tokens to assess profitability.