Impermanent loss is a loss that liquidity providers experience when token prices in their deposited pair diverge significantly from when they deposited.
Simple Example
You deposit to Uniswap liquidity pool:
- 1 ETH (worth $3,000)
- 6,000 USDC (worth $6,000)
- Total: $9,000
Week 1: ETH rises to $4,000
Market equilibrium: Uniswap automatically rebalances:
- Your new holdings: 0.866 ETH + 7,348 USDC
- ETH value: $3,464
- USDC value: $7,348
- Your total: $10,812
If you had just held:
- 1 ETH = $4,000
- 6,000 USDC = $6,000
- Would have: $10,000
Impermanent loss: $10,812 - $10,000 = -$188 “loss” vs holding
Wait, that’s a gain? Yes—but you lost potential gain. That’s the opportunity cost.
The Real Loss
When price diverges even more ($5,000 ETH):
- Your holdings: 0.77 ETH + 7,696 USDC = $10,546
- If you held: 1 ETH + 6,000 USDC = $11,000
- Impermanent loss: -$454 (real loss this time)
Why It Happens
Liquidity pools maintain price ratios automatically. When prices move:
- Pool automatically sells winners, buys losers
- You end up with more of the depreciating asset
- If price moves back, loss is “temporary” (impermanent)
- If price stays moved, loss is permanent
Mitigation
- Stable pairs: Deposit stablecoin pairs (minimal divergence)
- Fee income: Earn trading fees to offset impermanent loss
- Short-term liquidity: Provide liquidity only briefly
- Concentrated liquidity: Narrow your price range
- Avoid volatile pairs: Don’t pair BTC + shitcoin
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