Impermanent Loss

Impermanent Loss (IL) occurs when you provide liquidity to an AMM pool and the price ratio of your deposited tokens changes compared to when you deposited them. The "loss" represents the difference between the value of your LP position versus if you had simply held the original tokens.

Why It Happens:

When you deposit tokens into an AMM pool at a 50/50 ratio (by value), the AMM maintains this ratio through rebalancing. If one token's price rises, the pool automatically sells some of it and buys more of the other token to maintain balance. You end up with less of the appreciating asset.

Impermanent Loss Example:

Initial deposit: 1 ETH ($1,000) + 1,000 USDC Total value: $2,000

If ETH doubles to $2,000: - Just holding: 1 ETH ($2,000) + 1,000 USDC = $3,000 - In LP pool: ~0.707 ETH ($1,414) + 1,414 USDC = $2,828 - Impermanent Loss: ~5.7% ($172)

IL by Price Change (standard 50/50 pool): - 1.25x price change: ~0.6% IL - 1.5x price change: ~2.0% IL - 2x price change: ~5.7% IL - 3x price change: ~13.4% IL - 5x price change: ~25.5% IL

Why "Impermanent"?: The loss only becomes permanent when you withdraw. If prices return to the original ratio, IL disappears. However, if you withdraw while prices are diverged, the loss is realized.

Mitigating IL: - Choose correlated pairs (stablecoin-stablecoin) - Use concentrated liquidity strategically - Ensure trading fees + rewards outpace IL - Use IL protection protocols when available