What is Impermanent Loss?

The so-what is simple: when you supply assets to a DeFi pool, your token balances shift automatically to keep the pool balanced. If one token shoots up in price, the pool sells it off. This means you end up with less of the booming asset than if you had just kept it in your wallet.

It is not a fee, nobody takes it from you, and you will never see a line item for it. It is a gap between two outcomes: what you have, and what you would have had by doing nothing.

The banana analogy

Imagine you set up a stand with a friend where you put in 10 bananas and $10 cash (valuing bananas at $1 each). Anyone can swap bananas for cash using your stand.

If the price of bananas everywhere else spikes to $2, people will run to your stand, buy up your bananas for $1 cash, and sell them elsewhere. They will do this until your stand has no cheap bananas left. You are left with more cash but fewer bananas.

If you count up your cash and bananas, you are still up in total dollars, but you would have made more money if you had simply sat on your 10 bananas at home. That missed profit is impermanent loss.

The same thing with real numbers

Say you deposit $1,000 into a SOL and USDC pool. Pools take both sides in equal value, so that is $500 of SOL and $500 of USDC. If SOL is $100, you are putting in 5 SOL and 500 USDC.

Now SOL doubles to $200. Traders buy the cheap SOL out of your pool until its price matches the outside world. When the dust settles your share holds roughly 3.54 SOL and 707 USDC, worth about $1,414.

Had you done nothing, your 5 SOL would be worth $1,000 and your 500 USDC still $500, for $1,500. The $86 difference, about 5.7%, is the impermanent loss. You are up either way. You are just up less.

Notice what happened to the quantities. You did not lose dollars. You lost SOL. You walked in with 5 and walked out with 3.54, and the pool handed you dollars in exchange at prices on the way up. If your goal was to accumulate SOL, that matters more than the total.

How bad does it get?

The loss depends only on how far the two prices move apart, not on which one moved. A rough guide for a standard 50/50 pool:

• 1.25x apart (up 25%): about 0.6%
• 1.5x apart: about 2.0%
• 2x apart: about 5.7%
• 3x apart: about 13.4%
• 5x apart: about 25.5%

Two things follow. First, small moves cost almost nothing, which is why stablecoin pairs are popular. Second, the curve is brutal at the top end, which is why a volatile pair that ten-x es can leave you wishing you had held.

It is symmetric, too. A halving hurts exactly as much as a doubling, because down 50% and up 2x are the same ratio apart.

Why "impermanent" is a misleading word

The name comes from an honest observation: if the price ratio returns to where it started, the gap closes completely. Nothing was permanently destroyed. Ratios do wander back.

But the moment you withdraw, the gap stops being theoretical. Whatever it was on the day you exited is what you actually took. Many people read "impermanent" as "it will fix itself" and withdraw during exactly the divergence they were waiting out. A more useful name would be divergence loss, because that is what it measures and it makes no promise about reversing.

What offsets it

Every swap in the pool pays a fee, and those fees are yours in proportion to your share. That is the whole trade: you accept divergence loss in exchange for a cut of the trading.

So the real question is never "will I have impermanent loss" (you will, if prices move) but will the fees out-earn it. That depends on volume, on the fee tier, and on how long you stay. A busy pool at a 0.3% fee can out-earn a 5% divergence in months. A quiet pool with the same divergence never catches up.

Fees accrue continuously while you are in the pool. Divergence is a snapshot taken the day you leave. That asymmetry is why time in a high-volume pool tends to help you, and why jumping in and out tends not to.

Which pairs carry the least

• Two stablecoins: both are pinned to the same thing, so they rarely diverge. Very low risk, and correspondingly thin fees.
• A token and its staked version: these drift slowly and predictably.
• A volatile token against a stablecoin: the common case, and the one the numbers above describe.
• Two unrelated volatile tokens: the highest exposure, because either side can move against the other in either direction.

What people get wrong

"I lost money." Usually not. In the example above you gained $414. You simply gained less than holding. Impermanent loss is an opportunity cost, and it can sit alongside a real profit.

"It only happens if the price falls." It happens in both directions. Up is the case that surprises people, because the position still looks green.

"My advertised APR already accounts for it." It does not. A quoted pool APR is normally fee income only. The divergence is a separate line you have to work out yourself, which is exactly what the calculator below is for.

"I can avoid it by picking the right moment." You cannot time it, because it is driven by the ratio between two prices rather than by either price alone.

Run it on your own numbers

Put a deposit size and two price moves into the free Impermanent Loss Calculator and it shows the pool value against the hold value side by side. Then use the LP Profit Calculator to see whether the fees would have covered the gap.

FiLot is an analysis and bookkeeping tool, not financial advice. Providing liquidity carries real risk of loss, including from smart-contract failure and from tokens that lose value entirely, and past pool returns do not predict future ones.

Next: what a liquidity pool actually is, and what you receive when you deposit into one.