Impermanent loss (IL) is the most important concept for liquidity providers to understand. It represents the difference between holding tokens versus providing them as liquidity.
What Causes IL?
When you provide liquidity, the pool automatically rebalances as prices change. If one token appreciates, you end up with less of it than if you’d simply held. This “loss” is impermanent because it reverses if prices return to original ratios.
IL by Price Change
- 25% price change: 0.6% IL
- 50% price change: 2.0% IL
- 100% price change (2x): 5.7% IL
- 200% price change (3x): 13.4% IL
- 400% price change (5x): 25.5% IL
Managing IL
Choose correlated pairs (ETH/stETH) or stablecoins for minimal IL. Ensure expected fees exceed expected IL. Use concentrated liquidity carefully—it amplifies both fees and IL. Consider IL protection protocols when available.
IL isn’t inherently bad—it’s a tradeoff. Manage it as you would any investment risk.