Impermanent Loss

Impermanent loss is the value a liquidity provider gives up, compared with simply holding their tokens, when the prices of the assets in a pool diverge after they deposit. Automated market makers constantly rebalance a pool as traders swap against it, selling the appreciating token and accumulating the depreciating one. The result is that an LP's withdrawn assets are worth less than the same tokens would have been worth sitting untouched in a wallet.

A concrete example: you deposit ETH and USDC when ETH trades at 2,000 USDC. If ETH doubles to 4,000, arbitrage traders will have bought ETH out of the pool along the way, so on withdrawal you hold less ETH and more USDC than you deposited. Your position still gained value overall — but a few percent less than if you had just held the original tokens. The gap between those two outcomes is the impermanent loss.

The loss is called impermanent because it shrinks or disappears if prices return to their ratio at deposit time; it only becomes permanent when you withdraw. A common misconception is that trading fees always cover it — in stable, high-volume pairs they often do, but in volatile pairs the divergence can easily exceed fee income, leaving the LP worse off than a passive holder.