What is impermanent loss

Are you a liquidity provider in the crypto world? Learn what is impermanent loss and how to mitigate its impact on your investments.

If you’re involved in the world of cryptocurrencies, you may have heard the term “impermanent loss” before. But what exactly does it mean, and why should you care? In this article, we’ll take a closer look at what impermanent loss is, how it works, and what you can do to mitigate its impact.

What is Impermanent Loss – Definition

Impermanent loss is a concept that affects liquidity providers in automated market makers (AMMs). AMMs are a type of decentralized exchange that allows users to trade cryptocurrencies without relying on centralized intermediaries.

In an AMM, liquidity providers deposit equal amounts of two different cryptocurrencies to create a liquidity pool. Traders can then buy and sell these cryptocurrencies from the liquidity pool, with the price determined by the supply and demand of each cryptocurrency.

However, in an AMM, the value of the two cryptocurrencies in the liquidity pool can fluctuate over time. This means that if the price of one cryptocurrency increases or decreases, the value of the liquidity pool also changes. This can lead to impermanent loss for liquidity providers, as we’ll explain in the next section.

What is impermanent loss
Impermanent loss is a loss that can affect those who provide liquidity in DeFi pools.

How Impermanent Loss Works

Impermanent loss occurs when the price of one of the cryptocurrencies in the liquidity pool changes significantly. When this happens, the liquidity provider’s share of the liquidity pool changes as well. The liquidity provider may end up with more of one cryptocurrency and less of the other than they originally deposited, due to changes in the value of the two cryptocurrencies.

In other words, impermanent loss occurs when the liquidity provider would have been better off simply holding their original cryptocurrencies instead of depositing them into the liquidity pool. This is because they would have avoided the fluctuations in value that come with being a liquidity provider.

Real-Life Examples of Impermanent Loss

There have been many real-life examples of impermanent loss in the history of cryptocurrency. For instance, when the price of Ethereum skyrocketed in early 2021, liquidity providers who had deposited Ethereum and another cryptocurrency into an AMM may have experienced impermanent loss as the value of their Ethereum in the liquidity pool decreased relative to the other cryptocurrency.

This meant that they would have been better off simply holding their original Ethereum instead of depositing it into the liquidity pool.

The Impact of Impermanent Loss

The impact of impermanent loss can be significant for liquidity providers. In some cases, the losses can outweigh the gains from providing liquidity. This can lead to liquidity providers withdrawing their funds from the liquidity pool, which can in turn impact the liquidity and trading volume of the AMM.

Signs of Potential Impermanent Loss

There are a few warning signs that liquidity providers should look out for when deciding whether to provide liquidity to an AMM. These include:

  • Large price differences between the two cryptocurrencies in the liquidity pool
  • High volatility in the prices of the two cryptocurrencies
  • Low trading volume in the AMM
  • Low liquidity in the liquidity pool

How to Mitigate Impermanent Loss

There are a few ways to mitigate the impact of impermanent loss as a liquidity provider. These include:

  • Diversifying your investments: By providing liquidity to multiple AMMs or liquidity pools, you can spread out your risk and minimize the impact of impermanent loss on your overall portfolio.
  • Practicing risk management: Only provide liquidity that you can afford to lose, and monitor the performance of your liquidity provision carefully.
  • Avoiding AMMs with high volatility or low liquidity: Look for AMMs with a balanced ratio of trading volume and liquidity in the liquidity pool.


In summary, impermanent loss is a concept that affects liquidity providers in automated market makers. It occurs when the price of one of the cryptocurrencies in the liquidity pool changes significantly, leading to a loss for the liquidity provider.

By understanding what is impermanent loss, the risks and taking steps to mitigate them, liquidity providers can minimize the impact on their investments. This includes diversifying their investments, practicing risk management, and avoiding AMMs with high volatility or low liquidity.

As with any investment, it’s important to do your due diligence before providing liquidity to an AMM. This means researching the project, analyzing its performance and potential, and staying up-to-date on any news or developments that could impact its value. By staying informed and being vigilant, investors can help build a more trustworthy and reliable cryptocurrency market.

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