Introduction to Impermanent Loss

Impermanent loss is the difference between holding a token and providing liquidity for it in an automated market maker pool. It is called impermanent because it reverses if prices return, and permanent the moment you withdraw after a large move.

The name is misleading in one respect: it is the defining risk of every liquidity pool, and it is permanent exactly when it matters.

How a liquidity pool prices assets

A pool holds two assets in a fixed ratio. When you deposit, you receive pool shares that track your portion.

Trades against the pool move the ratio. When one asset is bought heavily, the pool sells it and buys the other, so the pool ends up holding more of the asset that fell. That is how the price is discovered without an order book.

You end up with more of the loser and less of the winner. That outcome is the loss.

The actual calculation

For a 50/50 pool, the divergence between holding and providing is roughly the square of the price ratio change, divided by four.

That means a token that triples against the other side produces a loss on the order of twenty-five percent of the deposited value, while simple holding would have kept the full gain. A token that goes up tenfold produces a much larger figure, and the loss grows with the square of the move rather than linearly.

This is why the risk is negligible in stable pairs and severe in volatile ones.

Comparing against the fees

A pool charges a fee on every trade that occurs against it. That fee is paid to liquidity providers and is where the return comes from.

The comparison that matters is whether the fees earned exceed the divergence loss over the same period. In a sideways market with high volume, they usually do. In a strongly trending market, the divergence loss usually exceeds the fees, and that is exactly when most providers withdraw.

Why it happens to you specifically

The loss is not a fee and nobody takes it. It is the opportunity cost written into the pool design, and it applies whether the provider knew about it or not.

It is most painful for someone who deposited near a local high expecting to sell later. From their position, the pool sold the asset they were holding through their own share of it.

Practical rules

• Concentrate liquidity in pairs you actually want to hold.
• Use wide ranges rather than tight ones, which concentrates capital and reduces out-of-range time.
• Accept that stable pairs such as two dollar-pegged assets have minimal divergence risk.
• Treat impermanent loss as a cost of providing liquidity, not as a separate mistake.

Why the label bothers people

Calling it impermanent was a marketing choice, and it is misleading in a way that costs people money. The loss is not guaranteed to reverse, because prices do not reliably return. What reverses is the position, not the outcome.

Once realised on withdrawal, it is a permanent reduction in what you hold, arrived at through a process that felt passive.

The case for providing anyway

Frequently asked questions

Is impermanent loss the same as a rug pull?

No. It is a mathematical property of how pools rebalance, not a theft. A pool can suffer it with nobody taking anything.

Does impermanent loss actually reverse?

It can, if prices return to their starting relationship before you withdraw. The moment you withdraw after a large divergence, it is realised and permanent.

How do I avoid it?

You cannot remove it, but you can limit it by providing liquidity in assets you want to hold regardless of price, and by choosing pairs where the expected fee income is realistic relative to the divergence risk.

Is concentrated liquidity safer?

No. Concentrated liquidity increases capital efficiency at the cost of concentrating risk, and a position goes out of range entirely when price leaves its band. The trade-off is efficiency, not safety.