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What is impermanent loss?

Learn what impermanent loss is, why it happens in DeFi liquidity pools and how to reduce its impact.

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By

Holly Jennings

Reviewed by

Richard Laycock

Updated

Fact checked

Providing liquidity in decentralized finance (DeFi) can earn you trading fees and rewards, but it carries a cost that catches a lot of liquidity providers off guard: impermanent loss. Before you deposit into a pool, it’s worth understanding how it works, how much it can cost you, and how to keep it in check.

Understand impermanent loss in 30 seconds

FeatureWhat it means
DefinitionA temporary loss in value that can occur when the price of assets in a liquidity pool changes compared with simply holding them
Who experiences itLiquidity providers (LPs) who deposit assets into a pool
CausePrice changes between the assets in the pool
Why “impermanent”The loss can shrink or disappear if asset prices return to their original ratio before you withdraw
When it becomes permanentWhen you withdraw your liquidity while the price ratio has changed
Trading feesFees earned from the pool can partially or completely offset impermanent loss
Greater riskLarger price changes between the paired assets generally mean greater impermanent loss
Key takeawayEarning fees doesn’t guarantee that providing liquidity will outperform simply holding the assets

What is impermanent loss?

Impermanent loss (IL) is the gap between what your tokens are worth after you deposit them into a liquidity pool and what they’d be worth if you had held them instead.

It happens because an automated market maker (AMM) keeps your pool balanced as prices move, quietly selling off whichever token is rising. As a result, you end up with less of the winner than if you’d done nothing.

It works in both directions regardless of which way the asset moves: a token doubling and a token halving cause the same-size loss. It’s only “impermanent” because nothing is locked in until you withdraw. If prices drift back to where they started, the loss fades. And the further prices diverge, the faster it grows.

Price change vs. depositImpermanent loss
1.25x (or −20%)~0.6%
1.5x (or −33%)~2.0%
2x (or −50%)~5.7%
3x~13.4%
4x~20.0%
5x~25.5%

Notice that a token doubling and a token halving produce the same impermanent loss. That’s because impermanent loss depends on how far the two assets move apart, not which direction they move.

The jump from a 2x move to a 5x move barely quadruples the price gap but more than quadruples the loss — which is why impermanent loss bites hardest on volatile pairs and is almost a non-issue for two stablecoins that barely move apart.

Why impermanent loss happens

To see where the loss comes from, it helps to know how a pool actually works. A standard liquidity pool holds two tokens in equal value — say ether (ETH) and US dollar coin (USDC) — and an AMM sets the price between them using a simple rule: the two quantities always multiply to the same number (x × y = k). Nobody has to match a buyer to a seller; traders just swap against the pool.

That rule is also what creates the loss. When ETH’s market price rises, the pool’s price lags behind, so arbitrage traders buy the cheaper ETH out of the pool until its price catches up. Every one of those trades leaves the pool holding a little less ETH and a little more USDC.

You still own your share of the pool — but the pool now holds fewer of the token that appreciated, so your share is worth less than if you’d simply held the two tokens yourself. That shortfall is the impermanent loss.

The catch is that you own a percentage of the pool, not a fixed number of tokens. So when you withdraw, you take out whatever mix the pool holds at that moment — and if prices have diverged, that mix has shifted against you.

Math example of impermanent loss

Say you deposit into an ETH/DAI pool when ETH is worth $100. You put in equal values — 1 ETH and 100 DAI, $200 total — and that gives you a 10% share of the pool. Over the week, ETH doubles to $200 on the open market. Arbitrage rebalances the pool, and here’s where you land when you withdraw your 10% share:

If you provided liquidityIf you’d just held
Starting deposit1 ETH + 100 DAI ($200)1 ETH + 100 DAI ($200)
Holdings after ETH doubles~0.707 ETH + ~141.42 DAI1 ETH + 100 DAI
Value at new prices~$282.82$300.00

Both positions gained — but the liquidity-provider (LP) position gained less. The $17.18 difference is your impermanent loss. Note that you didn’t lose money in absolute terms. You just earned less than the person who did nothing. That’s the trade-off for the fees you collect along the way, which this example leaves out.

For anyone who wants the underlying math, impermanent loss for a standard 50/50 pool is:

IL = 2√r / (1 + r) − 1, where r is the price ratio (new price ÷ deposit price)

At r = 2, that returns −5.7% — the same figure in the table above — and it’s the formula behind every row of the reference table.

How to reduce impermanent loss

Impermanent loss is part of how AMM-based liquidity pools work, so it can’t be eliminated entirely. However, these strategies can help reduce its impact:

  • Earn trading fees. Every swap generates fees that are shared with liquidity providers. In high-volume pools, those fees may outweigh impermanent loss over time.
  • Choose correlated assets. The closer two assets move together, the lower the risk of impermanent loss. Stablecoin pairs, liquid staking tokens (such as ETH/stETH) and wrapped versions of the same asset generally experience much smaller price divergence.
  • Use concentrated liquidity carefully. Concentrating liquidity within a price range can increase fee income, but if the price moves outside your range, your position may stop earning fees while remaining exposed to impermanent loss.
  • Consider single-sided or IL-protected pools. Some protocols let you deposit only one asset or offer partial protection against impermanent loss. These features can reduce risk but often come with lower yields or additional conditions.
  • Understand the pair’s volatility. Higher volatility usually means higher potential yields but also greater impermanent loss. More stable pairs tend to generate lower returns while exposing you to less price divergence.

Why would anyone accept impermanent loss?

Liquidity providers expect to earn more in rewards than they give up through impermanent loss. Most liquidity pools reward providers through one or more of the following:

  • Swap fees. Every trade made through the pool generates fees, which are distributed among liquidity providers proportional to their share of the pool.
  • Incentive rewards. Many DeFi protocols offer additional rewards to attract liquidity, often paid in the protocol’s native token or another cryptocurrency.
  • Token emissions. Some protocols regularly issue newly minted governance or utility tokens to liquidity providers as an extra source of yield.

Whether providing liquidity is profitable depends on the balance between these rewards and impermanent loss. In high-volume pools with strong incentives, fees and rewards may more than offset the loss. In volatile or low-volume pools, however, impermanent loss can exceed what you earn, leaving you worse off than if you’d simply held your tokens.

When does impermanent loss become permanent?

Despite the name, impermanent loss isn’t always temporary. It’s only “impermanent” as long as your assets remain in the liquidity pool. If the prices of the two assets return to the same ratio they had when you deposited them, the loss disappears.

Once you withdraw your liquidity, however, any impermanent loss is locked in. At that point, the pool’s rebalanced mix of assets becomes your new holdings, and the difference between that value and what you’d have by simply holding the original tokens becomes permanent.

In practice, many liquidity providers don’t wait for prices to return to their starting point. Instead, they weigh any impermanent loss against the trading fees and rewards they’ve earned. If those rewards exceed the loss, providing liquidity may still have been more profitable than simply holding the assets.

Which liquidity pools have the highest impermanent loss?

Not all liquidity pools carry the same level of risk. Impermanent loss depends on how much the two assets’ prices diverge after you deposit them. The more closely they move together, the smaller the loss is likely to be.

Pool typeTypical IL riskWhy
Stablecoin pairs (USDC/USDT, DAI/USDC)Very lowPrices are designed to remain close to one another.
Correlated assets (ETH/stETH, wrapped tokens)LowThe assets generally track the same underlying value.
Blue-chip token + stablecoin (ETH/USDC, BTC/USDC)ModerateOne asset can move significantly while the other remains stable.
Two unrelated cryptocurrenciesHighIndependent price movements increase divergence.
Small-cap token + stablecoinVery highLarge price swings can lead to substantial impermanent loss.

As a general rule, the pools offering the highest advertised yields are often the ones carrying the greatest impermanent loss risk.

Before providing liquidity, consider whether the expected trading fees and rewards are enough to compensate for the potential loss if the two assets move sharply apart.

Bottom line

Impermanent loss is a normal part of providing liquidity in DeFi, but it doesn’t automatically mean you’ll lose money. Whether it’s worth the risk depends on the pool you choose, how much its assets diverge in price and whether trading fees and rewards outweigh the loss over time.

If you’re ready to start providing liquidity, research decentralized exchanges (DEXs) to find platforms with the pools, fees and incentives that match your investment goals.

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To make sure you get accurate and helpful information, this guide has been reviewed by Richard Laycock, a member of Finder's Editorial Review Board.
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Written by

Deputy Crypto Editor

Holly Jennings is the deputy crypto editor and updates writer at Finder, working with writers across all niches to deliver quality content to readers. She’s edited hundreds of financial articles ranging from credit cards to investments. With empathy at heart, she especially enjoys content that breaks down complex financial situations into easy-to-understand information. Prior to her role at Finder, she collaborated with dozens of small businesses to maximize the reach and impact of their blog posts, website copy and other content. In her spare time, she is an award-winning author for Penguin Random House, writing about virtual reality worlds, magical girls and lasers that go pew-pew. See full bio

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Holly has written 49 Finder guides across topics including:
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