Impermanent loss (IL) is the difference in value between holding tokens in an AMM liquidity pool versus simply holding the same tokens outside the pool. It happens because the pool rebalances automatically as prices change, and that rebalancing sells the appreciating asset and buys the depreciating one, the opposite of what a buy-and-hold investor wants.
How impermanent loss is calculated
The formula for IL on a standard x*y=k pool (Uniswap v2 style) depends only on the price ratio change between the two assets. If one asset doubles in price relative to the other, the LP position is worth 5.7% less than simply holding the same amounts outside the pool. If one asset goes up 5x, IL reaches 25.5%. The relationship is non-linear and always negative relative to holding: even if prices return exactly to where they started, IL disappears completely, which is why it’s called “impermanent.” But if prices don’t return, the loss is permanent when you withdraw.
The exact multiplier: for a price ratio change of r (e.g., r=2 means one asset doubled), IL = 2√r/(1+r) − 1. At r=2: 2×1.414/3 − 1 = −0.057, so −5.7%. At r=5: 2×2.236/6 − 1 = −0.255, so −25.5%. Concentrated liquidity (Uniswap v3) amplifies this: a position providing liquidity in a narrow range earns more fees per dollar but experiences IL faster when price moves outside the range, at which point the position converts entirely into the depreciating asset and earns zero fees until price returns. See our concentrated liquidity explainer for how range selection changes the IL profile.
What this means for traders
Fee income is what LPs bet can offset IL. The break-even calculation: a pool with 0.3% fees needs enough volume to earn back the IL from price movement. For a stablecoin/ETH pool where ETH doubles, you need to earn 5.7% in fees on your liquidity before withdrawing to break even. At $10,000 in liquidity earning 0.3% fees, you need roughly $190,000 in trading volume through your specific position, realistic in a high-volume pool, impossible in a thin one.
Correlated pairs reduce IL. A wstETH/ETH pool has minimal IL because both tokens track ETH closely. A BTC/ETH pool has moderate IL because both are risk-on assets that tend to move together. A small-cap altcoin/USDC pool has severe IL risk because the altcoin can 10x or go to near-zero while USDC stays flat. The highest fees are usually in the highest-volatility pools, which also carry the highest IL. Understanding the AMM mechanism is covered in our automated market maker explainer, and how fees accumulate across DeFi protocols is in our DeFi yield types guide.
A concrete example
You deposit $5,000 in ETH and $5,000 in USDC into a Uniswap v2 pool when ETH is at $2,000. ETH price rises to $3,000. The pool now holds less ETH and more USDC (it sold ETH as price rose). Your position is now worth approximately $9,487, vs $10,500 if you had simply held ($5,000 USDC + 2.5 ETH × $3,000 = $12,500 in equivalent units, but you entered with 2.5 ETH + $5,000, so held value = 2.5 × $3,000 + $5,000 = $12,500; LP value = ~$12,247, the difference varies by exact formula, but the point holds). That $253 gap on a $10,000 position after a 50% ETH price move is your impermanent loss. If you earned $300 in trading fees during that time, you net ahead by $47. If you earned $150, you lost $103 net versus holding.
Frequently asked questions
Does impermanent loss affect stablecoin pools? Barely. In a USDC/USDT pool, the price ratio almost never moves more than 1–2 basis points, so IL is negligible. This is why stablecoin LPs can earn attractive real returns: fee income far exceeds IL. The risk shifts to smart contract risk and depeg risk rather than IL.
Can you hedge impermanent loss? Partially. Some traders short the appreciating asset through a perp position to offset the pool’s automatic selling, but this adds funding rate cost and requires active management as the ratio changes. No hedge fully eliminates IL without also eliminating fee income potential.
Why is it called “impermanent”? Because if asset prices return to their original ratio at the time of deposit, the IL disappears entirely and the LP is left with only the fee income. It becomes permanent only when the LP withdraws while prices are at a different ratio than the entry point.
