What is impermanent loss?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 5 min
In short
Impermanent loss is the gap that opens between holding two tokens and depositing them in an AMM pool: the further the price ratio drifts from where you deposited, the less your share is worth than simply holding would have been. It is called impermanent because the gap closes if the ratio returns — but it becomes real the moment you withdraw.
Key points
- It is a gap versus simply holding the two tokens
- It is driven by the ratio between them, not either price alone
- If the ratio returns to the entry point, the gap disappears
- Withdrawing while the ratio is off makes the loss permanent
Definition
The shortfall between the value of a position in an AMM liquidity pool and the value of simply holding the same tokens in a wallet, caused by the change in the price ratio between deposit and withdrawal.
The mechanism starts with the AMM's formula, which keeps the pool balanced according to a fixed rule. When ETH rises on outside markets, arbitrageurs buy the now-cheap ETH out of an ETH/USDC pool until the prices line up. The pool ends up with less ETH and more USDC — it has effectively sold the asset that went up, so it captures less of the rise than holding would have.
The size of the gap scales with how far the ratio moves. A 2x move in one asset costs a few percent; larger divergences widen it sharply. Pairs whose ratio barely moves, such as two stablecoins, show almost none of it. The working rule is that the more independently the two assets move, the bigger the effect.
The word 'impermanent' comes from the fact that the gap returns to zero if the ratio returns to where you entered. That only helps if you can wait. Withdraw while the ratio is off and the shortfall is locked in. Pools do pay out a share of trading fees, but whether those fees exceed the gap depends on market conditions and pool volume, and cannot be known in advance.
Watch out for
- · If one token collapses, the pool ends up holding more of it, amplifying the hit to your position
- · Claims that trading fees always make up for it are wrong; whether they do is only known after the fact
- · In concentrated liquidity positions, drifting out of range leaves you holding one asset only, magnifying the effect