Impermanent Loss Explained with Simple Examples
Impermanent loss explained with worked examples: why liquidity providers can end up with less than if they had held, how to estimate it, and how to limit it.
Impermanent loss is the difference between what your tokens are worth inside a liquidity pool and what they would have been worth if you had simply held them in your wallet. It happens because automated market makers (AMMs) constantly rebalance your deposit as prices change, leaving you with more of the token that fell and less of the token that rose.
If you are thinking about providing liquidity on a decentralized exchange, impermanent loss is the single most important cost to understand. Fees and rewards can look attractive, but they only make sense if they are larger than the value you give up by being in the pool. This guide uses simple numbers so you can estimate the effect yourself.
Why Impermanent Loss Happens
Most simple AMMs, such as the original Uniswap design, keep two tokens in a pool and follow the rule x × y = k: the quantity of token A multiplied by the quantity of token B must stay constant (ignoring fees). Prices are not set by an order book but by the ratio of tokens in the pool.
When the market price of one token rises elsewhere, the pool's price is briefly out of date. Arbitrage traders buy the cheap token from the pool until its price matches the market. They take the rising token out and put the other token in. As a liquidity provider, you own a share of that pool, so you end up holding less of the token that went up and more of the one that didn't. The arbitrageurs' profit is, in effect, your impermanent loss. Our article Yield Farming Explained expands on this point.
If you are new to pools, start with our explainers on liquidity pools and automated market makers.
A Simple Worked Example
The prices below are hypothetical and chosen for easy arithmetic.
You deposit 1 ETH and 2,000 USDC into an ETH/USDC pool when 1 ETH = 2,000 USDC. Your deposit is worth 4,000 USDC, and the pool's constant is 1 × 2,000 = 2,000.
Now ETH's market price doubles to 4,000 USDC. Arbitrage rebalances the pool until the ratio matches. Your share now contains:
- ETH: √(2,000 ÷ 4,000) ≈ 0.707 ETH
- USDC: √(2,000 × 4,000) ≈ 2,828 USDC
| Scenario | ETH held | USDC held | Value at ETH = 4,000 |
|---|---|---|---|
| Held in wallet | 1.000 | 2,000 | 6,000 USDC |
| In the pool | 0.707 | 2,828 | 5,657 USDC |
| Difference | −343 USDC (about −5.7%) |
You still made money compared with your original 4,000 USDC, but you made about 343 USDC less than if you had just held. That gap is impermanent loss, before counting any trading fees you earned. We cover this in more detail in How to Read a DEX Pool Page Before Trading.
How Big Does It Get?
For a standard 50/50 constant-product pool, impermanent loss depends only on how far the price ratio has moved from your entry point:
| Price change of one token vs the other | Impermanent loss vs holding |
|---|---|
| 1.25x (or 0.8x) | about 0.6% |
| 1.5x (or 0.67x) | about 2.0% |
| 2x (or 0.5x) | about 5.7% |
| 3x (or 0.33x) | about 13.4% |
| 4x (or 0.25x) | about 20.0% |
| 5x (or 0.2x) | about 25.5% |
The formula is: loss = 2 × √r ÷ (1 + r) − 1, where r is the new price ratio divided by the old one. Notice the symmetry: a token halving produces the same percentage loss as a token doubling. If you want to go further, read Where Does DeFi Yield Come From?
Why It's Called "Impermanent"
If prices return to exactly where they were when you deposited, the pool's composition returns too, and the loss disappears. Meanwhile, you keep any trading fees you earned. That is the best case for a liquidity provider. Our article Uniswap vs Curve expands on this point.
In practice, prices rarely return neatly. If you withdraw when the ratio has changed, the loss is locked in. Many people find "impermanent" misleading for this reason; "divergence loss" is a more accurate name you will also see. For a related token's outlook, see our SushiSwap price prediction for 2026–2027.
Concentrated Liquidity Makes It Sharper
Newer AMM designs let you provide liquidity in a chosen price range. This earns more fees per dollar while the price stays in range, but it also magnifies impermanent loss. If the price moves outside your range, your position becomes entirely the weaker asset and stops earning fees. See concentrated liquidity explained before using these pools. Related reading: Protocol-Owned Liquidity Explained.
How to Limit Impermanent Loss
- 1Choose correlated pairs. Stablecoin pairs or pairs like a token and its liquid-staking version move together, so the ratio changes little. Watch for depeg risk instead.
- 2Run the numbers first. Estimate the loss for plausible price moves using the table above and compare it with realistic fee income, not the headline yield.
- 3Treat reward tokens with caution. High yields paid in a project's own token can fall in value quickly and may not cover the loss.
- 4Check pool volume. Fees come from trading activity. A pool with high deposits but little volume pays little.
- 5Don't provide liquidity for tokens you wouldn't hold. Impermanent loss means you will end up with more of whichever token falls.
- 6Remember other risks. Smart contract bugs, malicious tokens and rug pulls can cost far more than impermanent loss.
Bottom line
Impermanent loss is the price of letting an AMM rebalance your tokens automatically. It is predictable for a given price move, grows quickly with large swings and only pays off when trading fees exceed it. Before depositing, estimate the loss for a few price scenarios, compare it with honest fee expectations and read our guide on how to provide liquidity on a DEX and understand the risks.
Frequently asked questions
Is impermanent loss a real loss?
It is a real opportunity cost compared with simply holding the two tokens. It is called impermanent because it shrinks if prices return to where they were when you deposited. If you withdraw while prices are different, the loss becomes permanent, although trading fees may offset part or all of it.
Do trading fees cover impermanent loss?
Sometimes. In busy pools, fees can exceed impermanent loss over time, but in pools with low volume or large price moves they often do not. There is no guarantee either way, so compare estimated fees with the loss you would face under different price scenarios before depositing.
Do stablecoin pools have impermanent loss?
Pools of two stablecoins that hold their pegs have very little impermanent loss because the price ratio barely changes. The bigger risk is that one stablecoin loses its peg, in which case the pool tends to leave you holding more of the weaker coin.
Does impermanent loss happen when prices go up as well as down?
Yes. Impermanent loss depends on how much the price ratio between the two tokens changes, not the direction. A token doubling causes the same percentage impermanent loss as a token halving, relative to holding. What matters is how far the ratio moves from your entry point.