Impermanent loss

Impermanent loss is the difference in value between depositing tokens into a liquidity pool and simply holding those same tokens in a wallet. It arises because an automated market maker rebalances the pool as prices move, so when the two assets diverge in price the provider ends up holding relatively more of the weaker asset and less of the stronger one. The loss is called impermanent because it can shrink if prices return to their original ratio, but it becomes permanent once liquidity is withdrawn.

Why it matters

Impermanent loss is the central risk of providing liquidity and is frequently underestimated. Fee income can offset it, but in volatile pairs the divergence loss can exceed fees earned, leaving a provider worse off than doing nothing. Understanding it helps providers choose pairs sensibly, favouring correlated or stable assets when they want to limit divergence. The effect is asymmetric and grows with the size of the price move, so a large swing in one asset can produce a loss that modest fee income cannot recover, which is why the metric deserves attention before committing funds.

Common misunderstanding

The word impermanent leads people to assume the loss always reverses. It only reverses if relative prices return to where they started before withdrawal, which is not guaranteed. Withdrawing during divergence locks the loss in. It is also a real opportunity cost even while unrealised, not a mere accounting quirk that can be safely ignored when comparing providing liquidity against simply holding.

Related terms

See liquidity pool, automated market maker and DeFi.