KoinlyticsImpermanent loss is the single most misunderstood concept in DeFi. Providers deposit money into a liquidity pool expecting to earn fees. They see the APR advertised at 25% and think 'great, better than a savings account'. Then they withdraw six months later and have less than they would have if they had just held. What happened? Impermanent loss.
The setup
You deposit into an AMM pool (Uniswap, Curve, Raydium). Most pools are two-sided: 50% Token A + 50% Token B, both in equal dollar value. Say you deposit $500 of ETH + $500 of USDC.
The pool math (constant product for Uniswap V2, similar for most AMMs) requires that the product of the two token balances stays constant: eth_balance × usdc_balance = k.
Every trader who swaps ETH for USDC leaves more ETH in the pool and takes USDC out. The pool auto-rebalances to keep the product constant.
What happens when the price moves
Say ETH is $2,000 when you deposited. Now ETH goes to $4,000 (a 2x). What happens to your pool position?
Arbitrage traders will swap USDC into the pool for ETH until the pool's internal price matches the external market. This means the pool now holds LESS ETH and MORE USDC than when you started.
You started with $500 ETH + $500 USDC. You end with something like $707 ETH + $707 USDC = $1,414 total.
But if you had just HELD, you would have 0.25 ETH ($1,000 now) + $500 USDC = $1,500. That $86 gap is impermanent loss. The pool sold your ETH into strength.
How bad does it get?
The reference table
Why 'impermanent' is a misleading name
The IL only reverses if the price returns exactly to your entry ratio. In practice, that rarely happens. The moment you withdraw, whatever IL exists becomes permanent. Call it what it is: rebalancing cost.
How to think about it before providing liquidity
- Fees have to beat IL. A pool with 30% APR from fees but 25% IL from expected volatility is only 5% net.
- Stable pools have minimal IL. USDC/USDT will barely move, so IL is near zero. Fees are also lower.
- Concentrated liquidity (Uniswap V3) has amplified IL. Higher fees, but you get liquidated out of range and lock in bigger losses when price moves.
The rule
Check IL before checking APR. A high APR on a volatile pair is often just compensation for high expected IL. Anyone advertising 100% APR without showing IL exposure is either naive or predatory.