You provided liquidity on Uniswap, earned trading fees, and feel good about your DeFi gains. But when you check the actual value of your position, you’ve made less than if you’d simply held the tokens. What happened?
Welcome to impermanent loss—the hidden cost that affects every liquidity provider in DeFi. Research by Bancor found that over 51% of Uniswap v3 liquidity providers were actually unprofitable due to impermanent loss exceeding their fee earnings. Understanding this concept is essential before you provide liquidity anywhere.
What Is Impermanent Loss?
Impermanent loss (IL) is the difference in value between:
- Holding tokens in a liquidity pool
- Simply holding those same tokens in your wallet
When you provide liquidity, the pool constantly rebalances your position as prices change. This rebalancing means you end up with more of whichever token decreased in value and less of whichever token increased—the opposite of what you’d want.
Why “impermanent”? If prices return to their original ratio, the loss disappears. But in practice, prices rarely return exactly, so the loss often becomes permanent when you withdraw.
Why Does Impermanent Loss Happen?
How AMMs Work
Automated Market Makers (AMMs) like Uniswap use a simple formula to determine prices:
x × y = k (constant)
Where x and y are the quantities of each token in the pool. This means when one token’s quantity decreases (people buying it), the other must increase to maintain the constant.
The Arbitrage Process
When external market prices change:
- The AMM pool price becomes different from market price
- Arbitrageurs spot the discrepancy
- They buy the “cheap” token from your pool
- The pool rebalances to match market price
- You now hold more of the depreciating token, less of the appreciating one
The Impermanent Loss Formula
For a standard 50/50 pool:
IL = 2 × √(price_ratio) / (1 + price_ratio) - 1
Where price_ratio = new_price / original_price
IL by Price Change
| Price Change | Impermanent Loss |
|---|---|
| 1.25x (25% up or down) | 0.6% |
| 1.50x (50% up or down) | 2.0% |
| 2x (100% up or down) | 5.7% |
| 3x (200% up or down) | 13.4% |
| 4x (300% up or down) | 20.0% |
| 5x (400% up or down) | 25.5% |
Key insight: IL is the same whether price goes up or down by the same ratio. A 2x increase and a 50% decrease both cause ~5.7% IL.
Real-World Example with Numbers
Initial Deposit
- You deposit: 1 ETH ($2,000) + 2,000 USDC
- Total value: $4,000
- Pool ratio: 50/50
Price Changes
ETH price rises from $2,000 to $3,000 (1.5x increase)
After Rebalancing
The pool formula requires rebalancing. After arbitrageurs do their work:
- You now have: ~0.816 ETH + ~2,449 USDC
- Pool position value: (0.816 × $3,000) + $2,449 = $4,898
If You Had Just Held
- 1 ETH at $3,000 = $3,000
- 2,000 USDC = $2,000
- Total HODL value: $5,000
The Loss
- Pool value: $4,898
- HODL value: $5,000
- Impermanent loss: $102 (2.04%)
Important: You still made money ($898 gain). But you made $102 less than simply holding. That’s impermanent loss.
When Is the Loss Permanent?
Impermanent loss is only realized when you withdraw your liquidity. If you leave your position and prices return to the original ratio, IL returns to zero.
However:
- Prices rarely return to exactly the same ratio
- In volatile markets, divergence often increases over time
- The longer you stay in volatile pools, the more likely some loss becomes permanent
Impermanent Loss vs Trading Fees
Providing liquidity isn’t all downside—you earn trading fees. The key question: Do fees exceed IL?
The Profitability Equation
Net Profit = Fees Earned - Impermanent Loss
Example
| Metric | Amount |
|---|---|
| Liquidity provided | $10,000 |
| Time in pool | 30 days |
| Fees earned | $150 (1.5%) |
| Impermanent loss | $200 (2%) |
| Net result | -$50 loss |
Despite earning fees, you lost money compared to holding.
When Fees Beat IL
- High-volume pools (more trades = more fees)
- Stablecoin pairs (minimal price divergence)
- Correlated assets (stETH/ETH)
- Low volatility periods
How to Minimize Impermanent Loss
1. Choose Stablecoin Pairs
USDT/USDC, USDC/DAI, and similar pairs have near-zero price divergence. IL is essentially eliminated, though APYs are lower.
2. Choose Correlated Assets
- stETH/ETH (liquid staking derivative + underlying)
- WBTC/BTC equivalents
- Assets that tend to move together
3. Use Concentrated Liquidity Strategically
Uniswap v3 allows setting price ranges. Tighter ranges earn more fees but have amplified IL. Only use tight ranges if you’re actively managing positions.
4. Consider Single-Sided Options
Some protocols allow single-asset deposits. The protocol handles pairing internally, sometimes with IL protection.
5. Shorter Time Horizons
Enter during calm markets, exit before major expected volatility. Active management can reduce IL exposure.
6. Choose High-Volume Pools
More trading volume = more fees to potentially offset IL. Check pool volume on DeFiLlama or the DEX’s analytics.
Tools to Calculate Impermanent Loss
| Tool | Description |
|---|---|
| DailyDeFi IL Calculator | Simple IL calculator for price scenarios |
| APY.Vision | Track real IL on your actual positions |
| DeBank | Portfolio tracker with IL monitoring |
| Revert Finance | Uniswap v3 position analyzer |
IL on Different Platforms
Uniswap v2 (Standard 50/50)
IL as described above. Full range liquidity across all prices.
Uniswap v3 (Concentrated Liquidity)
Amplified IL within your chosen price range. You earn more fees but IL is magnified. If price exits your range, you hold 100% of one token.
Curve (Stablecoin Optimized)
Designed for similar-priced assets. IL is minimal because prices stay close together.
Balancer (Weighted Pools)
Allows non-50/50 ratios (80/20, etc.). Asymmetric IL based on weights—can reduce IL for one asset at cost of more for the other.
Advanced IL Concepts
Concentrated Liquidity and Amplified IL
Uniswap v3 introduced concentrated liquidity, allowing LPs to provide liquidity within specific price ranges. While this increases capital efficiency and fee earnings, it also amplifies impermanent loss significantly.
How amplification works:
- Full range liquidity (like v2): Standard IL as calculated above
- Narrow range (±10%): IL can be 10x or more amplified
- If price exits your range: You hold 100% of one token (maximum IL for that move)
Example: If you provide ETH/USDC liquidity in a $2,000-$2,200 range and ETH rises to $2,500, you’ll hold 100% USDC and 0% ETH—missing the entire upside while earning no fees outside your range.
IL in Multi-Asset Pools
Protocols like Balancer allow pools with 3+ assets. The IL calculation becomes more complex:
- IL occurs between each pair of assets in the pool
- Total IL is a combination of all pairwise divergences
- More assets generally means more IL exposure points
Asymmetric Pool Weights
Balancer also allows non-50/50 pools (e.g., 80/20 ETH/USDC). This affects IL distribution:
- The asset with higher weight has less IL exposure
- The asset with lower weight has more IL exposure
- 80/20 pools can reduce IL on the dominant asset by approximately 50% compared to 50/50
IL Protection Mechanisms
Some protocols have developed mechanisms to reduce or compensate for impermanent loss:
Bancor’s IL Protection
Bancor v2.1 introduced IL protection that increased over time:
- 30 days: 30% IL covered
- 100 days: 100% IL covered
- Protection paid in BNT tokens
Note: This protection was paused in 2022 due to unsustainability. It demonstrates that IL protection is expensive and difficult to maintain.
Options-Based Hedging
Advanced users can hedge IL using options:
- Buy put options to protect against price decreases
- Buy call options to capture upside you’d miss from IL
- Cost of options reduces overall yield
Protocol Insurance
Some DeFi insurance protocols offer IL coverage, though premiums can be high relative to expected losses.
When to Accept Impermanent Loss
Despite its name and negative connotation, IL isn’t always bad. Consider providing liquidity when:
High Volume Justifies Risk
If a pool generates 50% APY in fees and you expect 10% IL, you’re still profitable. Check historical volume on platforms like:
- TVL trackers like DeFiLlama
- DEX-specific analytics (Uniswap Info, Curve Analytics)
You’re Bullish on Both Assets
If you want exposure to both ETH and USDC anyway, earning fees while holding is better than just holding—even with IL.
Stable Pairs
USDC/USDT, FRAX/USDC, and similar pairs have near-zero IL. The tradeoff is lower APY, but it’s essentially risk-free yield compared to volatile pairs.
Correlated Asset Pairs
stETH/ETH and similar pairs (liquid staking derivatives paired with their underlying) maintain close price correlation, minimizing IL while earning staking rewards plus trading fees.
Common IL Misconceptions
“IL Means I Lost Money”
Not necessarily. If you deposited $10,000 and withdrew $11,000, you made $1,000—even if holding would have given you $1,200. You still profited; IL just measures the opportunity cost.
“IL Only Happens When Prices Drop”
IL occurs with any price divergence, up or down. A 2x price increase causes the same IL as a 50% decrease. In bull markets, IL often means missing some upside rather than losing principal.
“Longer Time = More IL”
Time itself doesn’t cause IL—price movement does. A position held for a year with prices returning to original ratio has zero IL. A position held for one day with a 3x price move has 13.4% IL.
“High APY = Good Deal”
Extremely high APYs often indicate high IL risk. A 200% APY pool with highly volatile assets might leave you worse off than a 10% stable pool. Always factor in expected IL when evaluating yields.
Frequently Asked Questions
Is impermanent loss guaranteed?
No. If asset prices return to their original ratio, IL becomes zero. However, this is uncommon in practice, especially for volatile pairs.
Can impermanent loss exceed my investment?
No. IL is always a percentage loss compared to holding. You can never lose more than 100% of your position’s value from IL alone (though other risks like hacks can cause total loss).
Does impermanent loss apply to staking?
No. IL only affects liquidity provision in AMM pools with multiple assets. Single-asset staking (like ETH staking for rewards) doesn’t have IL.
Is it worth providing liquidity despite IL?
It depends. Profitable LP requires: high fee generation (volume), low volatility (stable or correlated pairs), or belief that prices will revert. Many sophisticated LPs are profitable, but casual LPs often are not.
Conclusion
Impermanent loss is the hidden cost of being a liquidity provider. Before depositing into any pool, understand:
- How much IL you might face based on potential price movements
- Whether expected fees can offset that IL
- Your time horizon and price expectations
For beginners, stablecoin pools or single-sided options offer a safer entry point. As you gain experience, you can explore more volatile pairs—but always calculate potential IL before committing capital.
Related articles:
- What is an Automated Market Maker?
- <a href="/understanding-and-minimizing-slippage-in-crypto-trading/”>Understanding Slippage in Crypto
- TVL in Crypto Explained
