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What Is Impermanent Loss?

Impermanent loss is what happens to your money when you provide liquidity to a trading pool and the two assets change price relative to each other. The pool automatically sells your winner to buy your laggard, so you end up worth less than if you had simply held the coins in your wallet. The gap is the loss.

How It Actually Works

A liquidity pool holds two assets in balance. When one rises, traders drain it from the pool and pay in the other, constantly rebalancing you away from the asset that is going up. If one asset doubles while the other sits still, a 50/50 pool leaves you about 5.7 percent behind just holding. If it goes up five times, you are about 25 percent behind. Trading fees are supposed to pay you for accepting that drag. Sometimes they do. Often they do not.

Risks and Common Mistakes

• Chasing a high advertised yield without asking what divergence will cost. The yield is quoted. The loss is not.
• Thinking "impermanent" means temporary. It only reverses if prices return to your entry ratio. Withdraw while diverged and the loss is permanent.
• Providing liquidity for volatile pairs, especially memecoins, where divergence is the whole point of the asset.

When It Matters

Any time DeFi offers you yield for depositing two assets. Run the numbers first with my free Impermanent Loss Calculator, and read the DeFi section of my NFTs and DeFi page for the bigger picture.

Related Terms

• Liquidity pool
• Liquidity
• DEX

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