What Is Impermanent Loss?
Impermanent loss (IL) is the difference in value between providing liquidity to an AMM pool and simply holding the same assets in your wallet. When the price ratio of the two pooled tokens changes, the AMM automatically rebalances your position — selling the appreciating asset and buying the depreciating one — resulting in less value than if you had just held.
How Impermanent Loss Works
The loss is "impermanent" because if the price ratio returns to the original ratio when you deposited, the IL disappears. If you withdraw at a different ratio, the loss becomes permanent. For a standard 50/50 AMM pool: a 2x price change in one token creates ~5.7% IL, a 3x change creates ~13.4% IL, and a 5x change creates ~25.5% IL.
Why It Matters for Traders
Impermanent loss is the primary risk for liquidity providers and must be weighed against fee income. If IL exceeds the trading fees earned, you would have been better off just holding. Strategies to minimize IL: provide liquidity to pairs with low price divergence (stablecoin pairs, correlated pairs), use concentrated liquidity to earn more fees (offsetting IL faster), or use protocols with IL protection mechanisms.
