What Is Impermanent Loss?
Impermanent loss (IL) is the difference in value between holding tokens in a liquidity pool versus simply holding them in your wallet. It occurs when the price ratio of tokens in the pool changes from when you deposited. The loss is "impermanent" because it reverses if prices return to the original ratio.
How Impermanent Loss Works
When you provide liquidity to an AMM pool (e.g., 50% ETH / 50% USDC), the pool automatically rebalances as prices change. If ETH doubles in price, the pool algorithm sells ETH and buys USDC to maintain the ratio. You end up with less ETH and more USDC than if you had simply held. The difference is your impermanent loss.
A 2x price change in one token results in roughly 5.7% IL. A 5x change results in roughly 25.5% IL.
Why It Matters for Traders
IL is the primary risk for DeFi liquidity providers. It must be weighed against trading fee income and farming rewards. In volatile markets, IL can exceed earned fees, making the LP position net negative. Concentrated liquidity positions (Uniswap V3) amplify both fees earned and impermanent loss, requiring active management.
How It Shows Up for Perps Traders
Even if you mainly trade CEX perps, impermanent loss still matters when you hedge with spot, move collateral across chains, or compare DEX perps funding to CEX funding. Thin pool depth and oracle lag can widen the gap between the index you hedge and the book you trade.
Formula and Worked Example
Example numbers only (not a live quote).
Suppose you compare a spot bag and a short perp hedge. If the hedge notional is $5,000 and the spot bag drifts 2% while the hedge mark moves 1.2%, the residual basis is 0.8% of notional, or $40 on that $5,000 book. That gap is the cost of an imperfect hedge, separate from funding.
Common Mistakes
- Treating a single print of impermanent loss as a trade signal without checking funding, open interest, and your liquidation price.
- Mixing venue conventions (coin-margined vs USDT-margined, cross vs isolated) and reading the wrong mark.
- Copying example numbers from a glossary into live size without checking the current book depth and fee schedule.
- Ignoring related terms that change the meaning of the print on a given day.
