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Impermanent loss is the temporary value loss a liquidity provider suffers when the price ratio of a pool's two tokens changes, relative to simply holding the tokens.
Impermanent loss (IL) is the defining risk of providing liquidity to an automated market maker. When you deposit two tokens into a liquidity pool and their prices diverge, the constant-product formula forces the pool to hold less of the rising token and more of the falling token. Your position ends up worth less than if you had simply held the two tokens outside the pool.
The loss is called "impermanent" because if the prices return to their original ratio, it disappears. But prices often do not return, and at that point you withdraw a position worth less than the alternative — at which point the loss becomes permanent. IL grows with price divergence: a 2x price change costs roughly 5.7%, a 3x change costs roughly 20%, a 5x change costs roughly 25.5%.
Mitigations include providing liquidity for tokens that trade closely together (stablecoin-stablecoin pools, or staked-version pools like ETH/stETH) where divergence is minimal, choosing pools with high fees that exceed the expected IL, and using concentrated-liquidity venues carefully. Understanding IL is non-negotiable before depositing into any AMM pool.
Impermanent loss is the value gap between holding two tokens versus depositing them in a liquidity pool. When the tokens' prices diverge, the pool automatically rebalances against you, and your position becomes worth less than simply holding the tokens would have been.
Because if the two tokens' prices return to their original ratio, the loss disappears. The catch is that prices often do not return, and at that point withdrawing locks in the loss as permanent.
Provide liquidity for token pairs that trade closely together (like stablecoin-stablecoin or ETH/staked-ETH pools), choose pools whose fees exceed the expected IL, prefer protocols that reward LPs with extra tokens, and avoid depositing into volatile pairs where large price divergence is likely.
A liquidity pool is a smart-contract vault of paired tokens that decentralized exchanges use to enable automated, peer-to-contract trading without an order book.
Yield farming is the practice of moving crypto capital between DeFi protocols to maximize returns from staking, lending, and liquidity-provision incentives.
Staking is the act of locking up cryptocurrency to help secure a proof-of-stake network in exchange for periodic rewards, analogous to earning interest.
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