Provide liquidity. One token pumps. Pull out your position later.

Less money than if you'd done nothing. Just held both tokens in a wallet. That gap is impermanent loss.

High APY numbers on liquidity pools rarely account for it properly. Returns look great until you do the actual math against a simple hold.

The Mechanism

AMMs price tokens based on the ratio inside the pool. Not external market price. The ratio.

ETH pumps on Binance and Coinbase. Pool ratio is now wrong. Too much ETH relative to USDC at the new price. Arbitrageurs buy ETH from the pool cheaply, sell USDC in. Ratio corrects.

You just had your ETH sold on the way up by the rebalancing mechanism. Didn't ask for it. Happened automatically. That's the pool working as designed.

End result: less ETH than you deposited, more USDC. ETH kept running. You participated partially. Not fully.

What It Actually Costs

Deposit 1 ETH and 1,000 USDC. ETH at $1,000. Total in: $2,000.

ETH doubles to $2,000.

Wallet scenario. Still holding 1 ETH and 1,000 USDC. Worth $3,000. Simple.

LP scenario. Pool rebalanced the whole way up. Now holding roughly 0.707 ETH and 1,414 USDC. At new prices that's $2,828.

$172 difference on a 2x move. Roughly 5.7%.

ETH goes 5x. IL jumps to 25.5%. Wallet: $6,000. LP position: $4,472. Not a rounding error anymore.

10x move. IL hits 42.5%. That's not a fee. That's a significant portion of potential gains handed back to arbitrageurs.

Why It's Called “Impermanent”

If ETH returns to exactly $1,000 after pumping, pool ratio resets. IL disappears completely. Back to the same position as just holding.

Technically true. Practically irrelevant.

Prices almost never return to the exact ratio at deposit. Tokens that pump stay pumped or dump further. Either way ratio stays diverged. Impermanent in name. Permanent in most real outcomes.

Stablecoin Pools Are Different

USDC/USDT. Both tracking $1. Ratio barely moves. IL essentially zero.

Curve Finance built around this. Stablecoin swaps with minimal divergence between assets. High volume. Real fee revenue. No IL eating returns.

Same logic for correlated pairs. ETH/stETH both move similarly. Ratio stays close. Low IL. Makes sense as a liquidity position in a way ETH/MEMECOIN never does.

Volatile pairs with low volume are the worst combination possible. IL from price divergence, minimal fees to compensate. Common in DeFi. Consistently disappoints LPs who only looked at the APY.

Concentrated Liquidity

Uniswap V3 changed the math.

Specify a price range instead of providing across the entire curve. Capital concentrated where you expect price to trade. More fees when price stays in range. More efficient use of capital.

Price moves outside range. Position flips entirely to one asset. Above range, all USDC. Below range, all ETH. Full IL realized at the boundary. Fee generation stops until price returns.

Amplifies everything. Better returns when right. Worse IL when wrong. Active management required. Not passive income.

The Only Question That Matters

Will fees earned exceed IL suffered over the holding period.

No universal answer. Depends on volume, fee tier, price divergence, time held.

Stablecoin pool on Curve doing billions daily. Minimal IL. Real fees. Math usually works.

New volatile pair with $300,000 TVL and occasional volume. Significant IL on any move. Fees nowhere near enough. Math usually doesn't.

Tools like DeFiLlama and Uniswap's LP calculator help model this before committing. Running the numbers takes ten minutes. Assuming APY covers everything costs real money.

Impermanent Loss FAQ

Does IL apply to staking?

No. One asset. Nothing to diverge against. IL is specifically a two-asset liquidity provision problem.

Can you avoid it entirely?

Only on stablecoin pairs where both assets track the same value. Any volatile pair carries IL. Single-sided liquidity protocols claim to eliminate it but usually restructure who absorbs the risk rather than removing it entirely.