Definition
Impermanent loss (IL) is the temporary reduction in value experienced by liquidity providers in automated market maker (AMM) pools when the price ratio of the two deposited tokens diverges from the ratio at the time of deposit — compared to simply holding the same tokens outside the pool.
The loss is “impermanent” because if the price ratio returns to the original ratio before withdrawal, the loss disappears. However, if liquidity is withdrawn while prices are diverged, the loss becomes permanent.
Impermanent loss is the primary risk specific to AMM liquidity provision and affects all constant-product AMMs (Uniswap, SushiSwap, PancakeSwap). The magnitude of IL increases with price divergence: a 2× price change causes ~5.7% IL; a 5× change causes ~25.5% IL.
Impermanent Loss Calculation
Formula
IL = 2√r/(1+r) – 1, where r = price ratio change
Practical example
Initial deposit: 1 ETH ($3,000) + 3,000 USDC Total value: $6,000; Pool share: 1% of pool
ETH price rises to $9,000 (3× increase)
AMM rebalances to maintain x*y=k: Original: 100 ETH × 300,000 USDC = 30,000,000 k After price rise: ETH needed = √(k/new_price) = √(30M/9,000) = 57.7 ETH USDC in pool: 57.7 ETH × $9,000 = $519,615 USDC
Your 1% share after price rise
0.577 ETH ($5,193) + $5,196 USDC = $10,389 LP value vs. Simply holding: 1 ETH × $9,000 = $9,000 + $3,000 USDC = $12,000
Impermanent loss
$12,000 – $10,389 = $1,611 (13.4% loss)
IL by Price Change (constant product AMM):
1.25× price change → 0.6% IL 1.50× price change → 2.0% IL 2.00× price change → 5.7% IL 3.00× price change → 13.4% IL 5.00× price change → 25.5% IL 10.00× price change → 42.5% IL (catastrophic) “`
IL by AMM Type
| AMM Type | IL Magnitude | Use Case |
| Constant product (Uniswap v2) | Standard formula | General purpose |
| Concentrated liquidity (Uniswap v3) | Higher in-range; zero out-of-range | Active management |
| StableSwap (Curve) | Near-zero for stable pairs | Stablecoin/pegged assets |
| Weighted pools (Balancer) | Customizable with non-50/50 weights | Portfolio-like positions |
| Dynamic fees (Uniswap v4) | Fee should compensate for IL | Advanced configurations |
FAQ
Q: Does impermanent loss always happen when prices move?
Yes — any price divergence between the two pool tokens causes some IL in a constant-product AMM. The key question is whether trading fees earned exceed the IL incurred.
High-volume pairs (major stablecoins, ETH/stablecoins) generate substantial fees that often more than compensate for moderate IL.
Low-volume pairs with high volatility are the worst combination: significant IL from price movements with insufficient fee income to compensate.
Q: Does withdrawing liquidity at a loss “lock in” impermanent loss?
Yes. Impermanent loss is called “impermanent” because it can reverse if prices return to the original ratio. If you withdraw while prices are diverged, you realize the loss permanently.
However, many DeFi investors make the mistake of holding positions too long hoping for IL recovery while the price continues moving away.
When IL significantly exceeds your fee income and your price thesis is changed, it may be more rational to withdraw (crystallize the loss) and redeploy capital.
Q: How does Uniswap v3 change impermanent loss?
Uniswap v3 concentrated liquidity allows LPs to provide liquidity only within a specified price range. This dramatically increases capital efficiency (more fees per unit of capital) but changes IL dynamics.
When price stays within your range, you earn fees at a higher rate; when price moves outside your range, your liquidity becomes entirely one asset (full IL at the range boundary). Out-of-range positions earn zero fees while still being exposed to IL. V3 requires active management (adjusting ranges) to be effective long-term.
UPay Tip: Before providing liquidity to any AMM pool, calculate the break-even impermanent loss for your intended holding period.
If a pool pays 30% APY in fees and your token pair historically diverges by 2× over a year, you’re roughly breaking even (5.7% IL vs. 30% fees).
If the same pair diverges 5× (25.5% IL), you’d lose money vs. holding despite the 30% APY. Tools like APY.Vision, DeFi Lab, and Uniswap’s own calculator show historical IL and fees for existing pools.
Conservative LPs prioritize stablecoin pairs (USDC/USDT on Curve) where IL is minimal, sacrificing potential upside for predictable, lower-risk yields.
Disclaimer: This content is for educational purposes only and does not constitute financial advice.
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