Impermanent Loss
In simple terms
Imagine you give a store two equally-priced items to sell. If one item's price goes up while you're waiting, you've lost out because you could have sold it for more elsewhere. Impermanent loss is similar—it's the missed profit you experience when you lend crypto to a pool and its price changes before you withdraw your coins.
Definition
A temporary loss that occurs when providing liquidity to a pool and the price of your deposited assets changes.
In depth
Impermanent loss occurs in Automated Market Maker (AMM) pools when the price ratio of deposited token pairs diverges from their initial ratio at deposit. Liquidity providers maintain a constant product formula (x*y=k) across their share of the pool, forcing them to automatically rebalance by selling appreciated assets and buying depreciated ones. This arbitrage mechanism ensures fair pricing but leaves LPs with a lower total value compared to simply holding the original tokens, with losses amplifying as price divergence increases. The loss is 'impermanent' because it can be recovered if prices return to their original ratio, but it materializes permanently upon withdrawal at unfavorable price points.
How does Impermanent Loss work?
Impermanent loss is the gap between holding two tokens in a wallet and depositing them in a liquidity pool, and it appears whenever their relative price changes. The pool's formula forces arbitrage traders to rebalance it: as one token rises, they buy it out of the pool cheaply and add the other, so the provider ends up with less of the appreciating asset and more of the lagging one. The imbalance widens as the price ratio diverges further. It is called impermanent because the gap closes if prices return to the original ratio, and becomes permanent the moment you withdraw.
An example
Suppose a provider deposits 1 Token A at an illustrative $2,000 plus 2,000 stablecoins, a $4,000 position. Token A's price then doubles to $4,000. Arbitrage leaves the pool position at roughly 0.707 Token A and 2,828 stablecoins, worth about $5,657. Simply holding the original 1 Token A and 2,000 stablecoins would be worth $6,000. The roughly $343 gap, about 5.7 percent, is impermanent loss, before any trading fees earned.
Figures are illustrative only.
What beginners get wrong
- The name misleads people into treating the loss as temporary, when withdrawing while prices have diverged locks it in permanently.
- Impermanent loss is measured against holding the same tokens, not against your dollar cost, so a position can gain in dollars and still show it.
- Pairing a volatile token with a stablecoin exposes the full price divergence, while pairing two closely correlated assets keeps the effect small.
- Advertised pool APYs typically quote fee and reward income only and do not net out impermanent loss, overstating what a provider actually keeps.
Related terms
Part of
What is DeFi, and how does decentralized finance work? — the subject page for defi, with all 18 of its definitions in one place.
Educational only — not financial advice.