What Is Impermanent Loss?

In AMMs such as Uniswap, pools keep two assets in balance according to a specific formula. When the price of one of the assets changes in the outside market, arbitrageurs buy the relatively cheaper asset from the pool and add the other. As a result, the liquidity provider is left with less of the asset that gained value and more of the one that lost value. For example, in a pool containing ETH and a stablecoin in equal value, if ETH's price doubles, the liquidity provider's share becomes worth about 5.7% less than if they had held the assets without putting them in the pool.

The loss is called “impermanent” because if prices return to their ratio at the time the liquidity was deposited, the difference disappears. However, if the user withdraws their liquidity while prices are different, the loss becomes permanent. As the divergence between prices grows, the loss grows too; the direction in which the price moves does not change the result.

Liquidity providers aim to offset this risk with trading fees and liquidity mining rewards; if the fee income falls short of the loss, a net loss results. The risk is low for assets with close prices, such as stablecoin pairs; with concentrated liquidity models, the effect can be more pronounced.