Impermanent Loss Explained: What Every LP Needs to Know

Impermanent loss is the most misunderstood concept in DeFi. It’s the hidden cost of providing liquidity that catches many new LPs off guard. In this guide, we’ll break down exactly what it is, when it happens, and how to calculate it—complete with an interactive calculator.

What is Impermanent Loss?

Impermanent loss (IL) occurs when you provide liquidity to an automated market maker (AMM) like Uniswap, and the price of your deposited assets changes compared to when you deposited them. The “loss” is the difference between what you’d have if you simply held the tokens versus what you have in the liquidity pool.

Key insight: It’s called “impermanent” because if prices return to your entry point, the loss disappears. However, if you withdraw while prices are different, the loss becomes permanent.

Why Does Impermanent Loss Happen?

AMMs use a mathematical formula (x × y = k) to maintain balance between two tokens in a pool. When the price of one token changes, arbitrage traders rebalance the pool to match external market prices. This rebalancing is what causes impermanent loss.

Simple Example

Let’s say you deposit $1,000 into an ETH/USDC pool:

• $500 worth of ETH (0.5 ETH at $1,000/ETH)
• $500 worth of USDC (500 USDC)

If ETH doubles to $2,000:

• If you HODL’d: 0.5 ETH × $2,000 + 500 USDC = $1,500
• In the LP: The pool rebalances, you’d have ~$1,414
• Impermanent loss: ~5.7% ($86 less than holding)

The Impermanent Loss Formula

The exact formula for impermanent loss is:

IL = 2 × √(price_ratio) ÷ (1 + price_ratio) – 1

Where price_ratio = new_price ÷ original_price

IL at Different Price Changes

Price Change	Impermanent Loss
1.25x (25% up)	0.6%
1.50x (50% up)	2.0%
2x (100% up)	5.7%
3x (200% up)	13.4%
4x (300% up)	20.0%
5x (400% up)	25.5%

Important: IL works the same whether price goes up or down. A 50% drop causes the same IL as a 2x gain.

Try It Yourself: Impermanent Loss Calculator

Use our interactive calculator below to see exactly how impermanent loss affects your liquidity position. Try different price scenarios to understand the impact.

When is Impermanent Loss Worth It?

Impermanent loss isn’t necessarily bad—it’s a trade-off. You’re exposed to IL in exchange for earning trading fees and potentially farming rewards. The key question is: Do your earnings exceed your IL?

IL is More Acceptable When:

• Trading fees are high — High-volume pools generate more fees
• Farming rewards are generous — Token incentives can offset IL
• You’re bullish on both tokens — You’d hold them anyway
• Tokens are correlated — Stablecoin pairs or similar assets have lower IL
• You expect sideways movement — Low volatility = low IL

IL is Problematic When:

• One token pumps significantly — You would’ve made more just holding
• Fees and rewards are low — Not enough to compensate for IL
• You only wanted exposure to one token — Now you’re forced to hold both
• You need to exit during high volatility — IL crystallizes

Strategies to Minimize Impermanent Loss

1. Choose Correlated Pairs

Pairs that move together experience less IL:

• Stablecoin pairs: USDC/USDT, DAI/USDC (minimal IL)
• Wrapped pairs: ETH/stETH, BTC/wBTC
• Correlated assets: ETH/tokens that track ETH

2. Use Concentrated Liquidity

Uniswap V3 allows you to concentrate liquidity in specific price ranges. This can earn you more fees but also amplifies IL if price moves outside your range.

3. Time Your Entry

Enter pools when you expect low volatility or when you’re neutral on price direction. Avoid entering right before major events that could cause large price swings.

4. Focus on High-Fee Pools

Pools with high trading volume generate more fees to offset IL. Look for pools where daily fees exceed potential IL from expected price movement.

Impermanent Loss vs. Impermanent Gain?

Some people argue there’s also “impermanent gain” when prices move in your favor. Technically, when you’re in an LP:

• If prices go up, you have less of the appreciating asset than if you’d held
• If prices go down, you have more of the depreciating asset than if you’d held

The pool automatically “sells high” and “buys low” for you—which sounds good, but means you always end up with less of whatever is winning.

Key Takeaways

• Impermanent loss happens when token prices diverge from your entry point
• IL is “impermanent” only if you don’t withdraw while prices differ
• The more prices change, the greater the IL (works same for up or down)
• Trading fees and rewards can offset IL—do the math before providing liquidity
• Correlated pairs and stablecoin pools have minimal IL
• Use the calculator above to model different scenarios before committing capital

Next step: Use our Yield Farming ROI Calculator to see if the rewards outweigh potential impermanent loss.