DeFi Education5 min read
Impermanent Loss Explained: What Every LP Needs to Know
Understand impermanent loss — the hidden cost of providing liquidity — and learn strategies to minimize its impact.
What Is Impermanent Loss?
Impermanent loss occurs when the price ratio of tokens in a liquidity pool changes compared to when you deposited them. The loss is "impermanent" because it reverses if prices return to their original ratio.
A Simple Example
Deposit 1 ETH + 3,000 USDC when ETH = $3,000 (total: $6,000). If ETH doubles to $6,000, your pool share rebalances to ~0.707 ETH + ~4,243 USDC = ~$8,485. Simply holding would give $9,000 — the ~$515 difference is impermanent loss.
IL by Price Change
- 1.5x price change: ~2% loss
- 2x price change: ~5.7% loss
- 3x price change: ~13.4% loss
- 5x price change: ~25.5% loss
Strategies to Minimize IL
- Choose correlated pairs: ETH/stETH or USDC/USDT experience minimal IL
- Use stablecoin pools: Designed for 1:1 ratios
- Concentrated liquidity: Earn more fees within tight price ranges
- Evaluate total returns: Trading fees often compensate for IL in high-volume pools
Key Takeaway
Understanding IL is essential for profitable liquidity provision. The combination of fee income, strategic pair selection, and active management can make LP positions net positive.