Impermanent loss (IL) is the temporary loss in value experienced by liquidity providers (LPs) in an AMM liquidity pool compared to simply holding the same tokens outside the pool. It occurs whenever the price ratio of the two pool tokens changes from when the LP deposited. The larger the price divergence, the greater the impermanent loss. Impermanent because the loss is unrealised while the LP remains in the pool – if prices return to the original ratio, IL disappears. It becomes permanent when the LP withdraws at the new price ratio. Example: an LP deposits equal value of ETH and USDC. ETH doubles in price. The AMM rebalances the pool, selling some ETH as price rises, so the LP ends up with less ETH and more USDC than if they had simply held. The LP receives more USDC but misses out on full ETH upside. IL is highest in pools with high-volatility, uncorrelated assets; lowest in stablecoin pools (USDC/USDT) where prices rarely diverge. Trading fees earned by LPs can offset or exceed impermanent loss in high-volume pools, making careful pool selection crucial.
Example: Example: You deposit $10,000 into a 50/50 ETH/USDC pool when ETH equals $2,000 (5 ETH plus 5,000 USDC). ETH rises to $8,000. The pool rebalances: you now have 2.5 ETH plus 10,000 USDC equals $30,000. But holding gives: 5 ETH times $8,000 plus $5,000 USDC equals $45,000. IL cost $15,000 – partially offset by trading fees earned.
Learn more: Binance Academy – Impermanent Loss
