Automated market maker pools hold two, or sometimes more, assets and use a pricing formula to let traders swap between them. As traders buy and sell against the pool, its balance of each asset shifts in order to keep the formula's ratio in line with the wider market price. If one asset's price moves significantly relative to the other after a liquidity provider deposits into the pool, the pool ends up holding relatively more of the asset that fell in value and relatively less of the one that rose. As a result, withdrawing the position can be worth less than if the provider had simply held the two assets separately in a wallet instead of depositing them.
The loss is called "impermanent" because, while funds remain in the pool, it exists only on paper: if relative prices move back toward where they started, the gap can close on its own. It becomes a real, permanent loss the moment the provider withdraws while prices are still diverged. Whether the trading fees earned for providing liquidity offset this loss depends heavily on trading volume and how far prices have diverged. For pairs of assets with closely correlated prices, such as two stablecoins, impermanent loss tends to be small, but for volatile, uncorrelated pairs it can outweigh fee income entirely, which is a genuine risk to understand before providing liquidity to any pool.
Key takeaways
- Impermanent loss happens when the relative prices of pooled assets diverge, leaving a liquidity provider with less value than if they had simply held the assets.
- The loss is "impermanent" only while funds stay in the pool — it becomes locked in once the position is withdrawn while prices remain diverged.
- Trading fees earned from providing liquidity can offset impermanent loss, but for volatile or uncorrelated asset pairs the loss can outweigh the fees, which is a real risk to weigh beforehand.
Impermanent Loss — frequently asked questions
Can impermanent loss be avoided entirely?
It's difficult to avoid completely in a two-asset pool, though it tends to be smaller for pairs of assets whose prices move closely together, such as two stablecoins, compared with pairs that move independently.
Does impermanent loss mean I'll lose money overall?
Not necessarily. Trading fees earned from the pool can offset or exceed the impermanent loss depending on trading volume and how much prices diverge, but there's no guarantee the fees will be enough to cover it.
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