Impermanent Loss
Impermanent loss is the temporary loss in value that a liquidity provider may experience when the price of the tokens in a liquidity pool changes compared with simply holding those tokens in a wallet.
✦ Key Insight
Impermanent loss matters because many beginners see attractive DeFi yields and assume providing liquidity is easy income. In reality, if one token in the pair moves strongly relative to the other, the provider can end up with less total value than if they had just held the assets.
✕ Common Misconceptions
Many users chase high APY without calculating potential loss from price divergence. Others think fees will always offset the loss, which is not guaranteed. Another mistake is assuming stablecoin pairs and volatile pairs behave the same way.
Detailed Explanation
How It Works
When prices change inside a liquidity pool, the pool automatically rebalances. This means the amount of each token you hold in the pool changes too. If one token rises much faster than the other, you may end up with less of the stronger asset and more of the weaker one. The loss is called “impermanent” because it only becomes final when you withdraw, though the impact can still be very real.
FAQs
Why is it called impermanent loss?
Because if prices return to their original ratio, the loss can shrink or disappear.
Can impermanent loss become permanent?
Yes, once you withdraw from the pool.
Is impermanent loss always bad?
It is a risk, but trading fees can sometimes offset part of it.
In Practice
Dig Deeper
Slippage
The difference between the expected price of a trade and the actual executed price, usually due to volatility or low liquidity.
Liquidity Pool
A liquidity pool is a collection of crypto assets locked in a smart contract that allows users to trade tokens on decentralized exchanges without relying on a traditional order book.
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