Impermanent Loss Explained
Impermanent loss cost one ETH/SHIB LP $3,800 (-38%) in 2021 when SHIB crashed 82% vs ETH. Understanding IL math is critical - a 2x price change causes 5.7% loss, 5x causes 25.5% loss, even if both tokens gain value.
What is Impermanent Loss?
Impermanent loss is the difference between:
- Value if you simply held your tokens
- Value of your LP position
It occurs whenever the price ratio of pooled tokens changes from when you deposited.
Why Does It Happen?
AMM pools must rebalance to maintain equal value:
- If ETH price rises, arbitrageurs buy ETH from pool
- Pool ends up with less ETH, more stablecoins
- You now have less of the appreciating asset
- Result: You underperform vs. just holding
If prices return to original ratio, the loss disappears. It only becomes "permanent" when you withdraw at different prices.
Impermanent Loss Chart
| Price Change | Impermanent Loss |
|---|---|
| 1.25x (25% up or down) | 0.6% |
| 1.5x (50% change) | 2.0% |
| 2x (100% change) | 5.7% |
| 3x (200% change) | 13.4% |
| 4x (300% change) | 20.0% |
| 5x (400% change) | 25.5% |
IL happens whether price goes up or down. A 50% drop causes the same IL as a 100% gain (2x). Any price divergence creates IL.
Calculating Impermanent Loss
The formula for IL:
- IL = 2 * sqrt(price_ratio) / (1 + price_ratio) - 1
- Or use online IL calculators
Real Impermanent Loss Examples
Example 1: ETH Doubles (Moderate IL)
Deposit at ETH = $2,000:
2.5 ETH ($5,000) + $5,000 USDC = $10,000 total
ETH doubles to $4,000:
If you held: 2.5 ETH ($10,000) + $5,000 USDC = $15,000
In LP pool: 1.77 ETH ($7,071) + $7,071 USDC = $14,142
Impermanent Loss: $15,000 - $14,142 = $858 (5.7%)
You have less ETH because the pool sold some as price rose.
If fees earned: $950 over same period
Net result: +$92, LP was still profitable
Example 2: Altcoin Crashes (Severe IL)
Deposit May 2021:
$5,000 ETH + $5,000 SHIB = $10,000 total
December 2021 (SHIB down 82% vs ETH):
If you held: $6,000 ETH (up 20%) + $900 SHIB (down 82%) = $6,900
In LP pool: Pool rebalanced to ~$3,100 value
Impermanent loss: -$3,800 (55% loss vs holding)
Trading fees earned: ~$1,850
Final value: $6,200
Result: Lost $3,800 vs holding both assets
Even though you earned $1,850 in fees, IL destroyed returns
Example 3: Both Tokens Moon (IL Still Hurts)
Deposit: $5,000 ETH + $5,000 LINK = $10,000
3 months later:
ETH up 50% ($1 spent becomes $1.50)
LINK up 200% ($1 spent becomes $3.00)
If you held: $7,500 ETH + $15,000 LINK = $22,500
In LP pool: ~$19,365 total
Impermanent loss: $3,135 (14%)
Both tokens went up, but you lost vs holding because LINK outperformed ETH. The pool rebalanced, selling your LINK winners to buy more ETH.
Example 4: Stablecoins (Minimal IL)
Deposit: $5,000 USDC + $5,000 USDT = $10,000
1 year later:
USDC ranges $0.998-1.002
USDT ranges $0.997-1.003
If you held: ~$10,000
In LP pool: ~$9,992
Impermanent loss: $8 (0.08%)
Fees earned: $1,150 (11.5% APY)
Net profit: $1,142
Stablecoins work because prices don't diverge
When IL Matters Most
- Volatile pairs - ETH/random altcoin
- Strong price moves - Bull/bear markets
- Low fee pools - Fees don't offset IL
- Short time horizons - Less time to earn fees
When IL Matters Less
- Stable pairs - USDC/USDT has minimal IL
- Correlated assets - ETH/stETH move together
- High volume pools - Fees can exceed IL
- Long time horizons - More fees accumulated
LP is profitable when: Trading Fees Earned > Impermanent Loss. High volume pools with small price movements are ideal.
Strategies to Minimize IL
1. Choose Stable Pairs
- USDC/USDT - Negligible IL
- ETH/stETH - Same asset, different forms
- BTC/wBTC - Wrapped versions
2. Use Concentrated Liquidity Wisely
- Uniswap v3 amplifies both fees AND IL
- Narrow range = more fees but more IL risk
- Wide range = less of both
3. Time Your Entry/Exit
- Enter during stable periods
- Exit when prices return near entry
- Avoid adding during high volatility
IL vs. Trading Fees
The key question: Do fees cover IL?
| Scenario | Result |
|---|---|
| Fees > IL | Profitable LP position |
| Fees = IL | Break even (same as holding) |
| Fees < IL | Would have been better just holding |
IL Calculator: Common Scenarios
| Price Scenario | Price Ratio | IL % | Fees Needed to Break Even |
|---|---|---|---|
| ETH $2k → $2.5k | 1.25x | 0.6% | Easy (few days of fees) |
| ETH $2k → $3k | 1.5x | 2.0% | Moderate (1-2 weeks) |
| ETH $2k → $4k | 2x | 5.7% | Hard (1-2 months) |
| ETH $2k → $6k | 3x | 13.4% | Very hard (3-6 months) |
| Altcoin crashes 80% | 5x ratio change | 25.5% | Nearly impossible |
When Does IL Become Permanent?
IL Reverses If Price Returns
- ETH goes $2k → $3k → $2k = zero IL at end
- You kept all the fees earned during volatility
- This is why it's called "impermanent"
IL Becomes Permanent When You Withdraw
- Withdrawing locks in the IL
- You receive fewer tokens of the winner
- Can't wait for prices to revert
- This is the actual realized loss
Real Example: Timing Matters
Day 1: Deposit $10k (ETH at $2,000)
Day 30: ETH hits $3,500 (IL = 10.5%)
Day 90: ETH back to $2,100 (IL = 0.8%)
Total fees earned: $425
Patient LP who waited for price to stabilize:
Lost only 0.8% to IL but earned 4.25% in fees
Net: +3.45% profit
Impatient LP who sold on Day 30:
Lost 10.5% to IL, earned 1.5% in fees
Net: -9% loss
Advanced IL Mitigation Strategies
1. Stick to Low-Volatility Pairs
- Stablecoin pairs: USDC/USDT, DAI/USDC (0.1-0.5% IL)
- Wrapped assets: wBTC/renBTC, ETH/wETH (near zero IL)
- Correlated assets: ETH/stETH, MATIC/stMATIC (low IL)
2. Use Weighted Pools (Balancer)
- 80/20 pools instead of 50/50
- Example: 80% ETH / 20% USDC
- Reduces IL by ~50% vs traditional pool
- Still earn fees but less price exposure
3. Single-Sided Staking
- Some protocols (Bancor v2.1) offered IL protection
- Stake only one token, no pairs needed
- IL protection increased over time (full at 100 days)
- Warning: Many IL protection schemes failed
4. Options Hedging (Advanced)
- Buy put options on the volatile token
- Limits downside from price crashes
- Cost: Option premiums eat into profits
- Complex, only for sophisticated users
IL vs Fees: When Do You Win?
High-Volume Pools Can Overcome IL
Pool did $80M daily volume average
Annual fees: ~$8.8B × 0.3% = $26.4M
Pool TVL: ~$180M average
LP APY from fees: ~14.7%
ETH price volatility caused 8% average IL
But fees (14.7%) > IL (8%)
Net APY: +6.7%
LPs profited despite IL because volume was huge
Low-Volume Pools Often Lose
Pool: TOKEN/ETH
Daily volume: $50k
Annual fees: $50k × 365 × 0.3% = $54,750
Pool TVL: $2M
Fee APY: 2.7%
TOKEN crashed 70% vs ETH over 6 months
Impermanent loss: 42%
Fees earned in 6 months: 1.35%
Net result: -40.65%
Catastrophic loss despite earning fees
IL Horror Stories From Real LPs
The Terra/Luna LP Massacre (May 2022)
- LUNA/UST pools on Terraswap
- Both tokens went to near-zero in 48 hours
- LPs lost 99.9% regardless of IL
- Total losses: $40 billion across ecosystem
- Lesson: Protocol risk > IL risk
Uniswap v3 Concentrated Liquidity Wipeouts
- Narrow ranges (5-10%) promised 200-500% APY
- Price moves out of range = zero fees earned
- Rebalancing costs $50-150 in gas each time
- Many LPs spent more on gas than earned in fees
- Plus suffered IL on each rebalance
Successful IL Management: What Worked
- Curve stablecoin LPs (2020-2026): Consistent 8-15% APY, minimal IL
- Blue chip pairs during sideways markets: Fees exceed IL when prices stable
- Layer 2 LPs: Lower gas makes smaller positions viable
- Exit discipline: LPs who exited when APY dropped saved themselves
Over 60% of LPs would have made more money just holding both tokens instead of providing liquidity, according to 2020-2022 data analysis. Only stablecoin LPs and those in very high-volume pools consistently beat holding.
Before you LP, run the numbers: Will fees realistically exceed potential IL?