Impermanent loss: the LP's silent tax

When Providing Liquidity Costs You

Impermanent loss is the gap between the value of your deposit if it had stayed in a liquidity pool versus if you had simply held the two tokens. When the relative price of the pooled assets moves, the AMM automatically rebalances the pool by selling the appreciating asset and buying the depreciating one—so providers end up with more of the loser and less of the winner.

The math is unforgiving. If one asset doubles relative to the other, a constant-product LP captures roughly 5.7% less than simple holding. A 5x price ratio shift produces about 25% loss. The loss is called impermanent because if prices return to their original ratio, it disappears. But if the divergence persists or worsens, the loss becomes very real the moment the provider withdraws.

Trading fees and reward emissions are what compensate providers for taking this risk. A high-volume pool with 0.3% per-swap fees can easily out-earn impermanent loss for pairs that trade actively but stay close to a baseline ratio—stablecoin pairs, ETH/stETH, and similar correlated assets. For volatile, uncorrelated pairs the math can flip, and many sophisticated LPs hedge their exposure or stick to stable-asset pools entirely.