Understanding Impermanent Loss
Why providing liquidity to a pool can leave you worse off than simply holding the same assets.
What to remember
- Impermanent loss compares a liquidity position's value to simply holding the same assets.
- It occurs because AMMs automatically rebalance a pool's ratio as prices move.
- It's only realized upon withdrawal, and can become effectively permanent if prices don't revert.
- Trading fees earned may or may not offset the loss.
What impermanent loss is
Impermanent loss is the difference between the value of assets held in a liquidity pool and the value those same assets would have had if simply held in a wallet, occurring when the relative price of the pooled tokens changes after they were deposited.
Why it happens
An automated market maker automatically rebalances a pool's token ratio as prices move, which in practice means a liquidity provider ends up holding relatively more of whichever token has become less valuable and relatively less of whichever token has become more valuable, compared to their original deposit.
How holding and providing liquidity diverge from the same starting deposit as prices move.
Why it's called "impermanent"
- The loss is only realized if the liquidity provider withdraws while the price ratio is different from when they deposited.
- If the price ratio returns to where it was at deposit, the loss disappears.
- In practice, prices often don't return to their original ratio, so the loss can become permanent in practice, despite the name.
Fees earned can offset — or fail to offset — the loss
Trading fees collected while providing liquidity can offset some or all of impermanent loss, but there's no guarantee they will. Whether providing liquidity ends up ahead of simply holding depends on both price movement and the fees actually earned.
What to remember
- Impermanent loss compares a liquidity position's value to simply holding the same assets.
- It occurs because AMMs automatically rebalance a pool's ratio as prices move.
- It's only realized upon withdrawal, and can become effectively permanent if prices don't revert.
- Trading fees earned may or may not offset the loss.