What is Impermanent Loss?

Impermanent loss (IL) occurs when you provide liquidity to a pool and the price ratio of your deposited tokens changes. The more the prices diverge, the greater the loss compared to simply holding.

Why it happens: AMMs maintain constant product ratios. When prices change, arbitrageurs rebalance the pool, leaving you with more of the depreciated token and less of the appreciated one.

Example: You deposit $1000 of ETH and $1000 of USDC. If ETH doubles in price, your LP position might be worth $2,800 instead of $3,000 if you had just held. That $200 difference is impermanent loss.

'Impermanent' because: If prices return to original ratio, the loss disappears. It becomes permanent when you withdraw.

Mitigation: Farm stablecoin pairs (minimal IL), choose correlated assets, or ensure trading fees exceed IL.

Advanced mitigation strategies: Choosing highly correlated token pairs such as wBTC/renBTC or stETH/ETH dramatically reduces divergence risk. Concentrated liquidity positions on Uniswap V3 can improve fee earnings enough to offset IL, though they require active management. Some protocols now offer impermanent loss insurance or protection mechanisms that reimburse LPs after a minimum holding period. Evaluating the fee-to-IL ratio before entering any pool is essential for consistent profitability.