Impermanent Loss Explained: The Hidden Cost of Liquidity Providing

Provide liquidity to a trading pool and you'll earn fees — but you also take on a risk most beginners discover only after it costs them: impermanent loss (IL), the gap between what your deposit is worth inside the pool versus what it would be worth if you had simply held the tokens.

Why it happens

Automated market makers (AMMs) like Uniswap keep pools balanced with a pricing formula (classically x · y = k). When one token's market price rises, arbitrage traders buy it out of the pool until the pool price matches the market. The mechanical result: the pool sells your winner and accumulates your loser. You always end up holding less of whatever went up.

The math, worked through

Deposit 1 ETH ($2,000) + 2,000 USDC into a 50/50 pool. Total: $4,000.

Now ETH doubles to $4,000. Arbitrage rebalances the pool so your share becomes roughly 0.707 ETH + 2,828 USDC ≈ $5,657.

Had you just held: 1 ETH + 2,000 USDC = $6,000.

The difference — $343, about 5.7% — is impermanent loss. You still profited, but less than doing nothing.

Standard IL for a 50/50 pool by price change of one asset against the other:

Price change	Impermanent loss
1.25×	0.6%
1.5×	2.0%
2×	5.7%
3×	13.4%
5×	25.5%

It's called "impermanent" because if prices return to your entry ratio, the loss disappears. In practice prices rarely round-trip, so treat it as real.

When LPing still wins

The bet is simple: fees earned > impermanent loss suffered. That favors:

• Stable pairs (USDC/USDT): near-zero IL, so any fee income is nearly pure profit — check current rates on our yields page.
• Correlated pairs (ETH/stETH): move together, tiny IL.
• High-volume pools: heavy trading generates fees fast enough to outrun moderate IL.
• Incentivized pools: reward tokens can offset IL — but discount rewards paid in a token that may itself collapse.

Concentrated-liquidity AMMs (Uniswap v3-style) amplify both sides: more fees per dollar inside your chosen range, but sharper IL when price exits it.

Bottom line

Never LP a volatile pair just for the headline APY. Estimate what a big price move would cost you against holding, compare it to realistic fee income, and prefer stable or correlated pairs while you're learning. Volume pays you; volatility charges you.