Impermanent Loss concept

Concept · PageRank 0.0000

Overview

Impermanent loss is the shortfall a liquidity provider in an automated market maker experiences relative to simply holding the deposited tokens, caused by the pool's rebalancing when the relative price of the assets changes. As the external market price moves, arbitrageurs trade against the pool, leaving the provider holding more of the asset that fell and less of the asset that rose. The loss is called 'impermanent' because it disappears if prices return to their original ratio, but becomes permanent once the provider withdraws. Larger price divergences produce larger losses, and providers may offset them with accumulated trading fees when pool volume is high.

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Frequently asked questions

Why is the loss called 'impermanent'?

Because it reverses if the token prices return to their original ratio; it only becomes a realised, permanent loss when the liquidity provider withdraws.

What causes impermanent loss mechanically?

When the pool price drifts from the outside market price, arbitrageurs rebalance the pool, so the provider ends up with more of the depreciating asset and less of the appreciating one than if they had just held.

Can liquidity providers offset impermanent loss?

Yes — with sufficient trading volume, the fees earned on swaps can offset or exceed the impermanent loss, though this is not guaranteed.