Why is it a loss if the price went up?
Suppose you deposit ETH and USDC into a liquidity pool and ETH then doubles. Your position is worth more in dollars, but it would have been worth even more if you had simply held the two assets. That shortfall is called impermanent loss.
This guide explains why impermanent loss happens, calculates how it grows as relative prices move, and sets out when trading fees can offset it, using hypothetical numbers. It ends with criteria to check before depositing.
Two outcomes to compare
Impermanent loss compares the value of a pool position with the value of holding the same assets outside the pool. It is measured against holding, not against your starting capital. Even if the position is up in dollars, you have impermanent loss if it is up less than holding would have been.
It is called impermanent because the loss disappears if the price ratio returns to where it was at deposit. Withdraw while the ratio is still different, though, and the loss becomes permanent.
How the pool's asset mix shifts
A constant-product pool keeps the product of the two asset quantities fixed. When ETH rises on other markets, arbitrageurs buy the relatively cheap ETH from the pool and add USDC, so the pool ends up holding less ETH and more USDC. The BIS Quarterly Review explains that AMM prices are set by the ratio of pooled assets and kept in line with outside markets by arbitrage.
In effect, an LP automatically sells the asset that is rising and buys the one that is falling. The further prices move in one direction, the less of the winner and the more of the loser the LP holds, and the more the result lags simply holding.
The numbers for different price moves
In this hypothetical example, an LP deposits 1 ETH and 3,000 USDC when 1 ETH = 3,000 USDC, a total of $6,000. Fee income is excluded.
| ETH price | Price ratio change | Pool position value | Value if held | Vs. holding |
|---|---|---|---|---|
| 1,500 USDC | 0.5× | ≈ 4,243 | 4,500 | ≈ -5.7% |
| 3,750 USDC | 1.25× | ≈ 6,708 | 6,750 | ≈ -0.6% |
| 6,000 USDC | 2× | ≈ 8,485 | 9,000 | ≈ -5.7% |
| 12,000 USDC | 4× | 12,000 | 15,000 | -20.0% |
Loss versus holding = 2√r ÷ (1 + r) − 1, where r is the change in the price ratio. A halving and a doubling produce the same percentage loss.
When fees change the outcome
LPs accept impermanent loss in exchange for trading fees. In the example, if fees earned while ETH doubled exceeded about 5.7% of the position, the LP would have done better than holding once fees are included.
Fee income rises with trading volume and falls with pool size. Pools with heavy trading but modest price swings favor LPs; pools of assets that trend sharply in one direction often see fees fail to keep up. Pools of two assets that move together, such as two dollar stablecoins, have small impermanent loss.
Pool and token checks
Ethereum.org's overview of DeFi describes providing liquidity as a way to earn fees that comes with smart-contract and market risk. Beyond impermanent loss, a pooled token can collapse in value, or a look-alike token can be paired in a pool.
Some AMMs let LPs concentrate liquidity within a chosen price range. That can earn more fees from the same capital, but if the price leaves the range, the position ends up entirely in one asset, stops earning fees, and impermanent loss can be larger.
Before you deposit
Use these steps when considering providing liquidity.
- Look at how far the two assets' relative price has moved historically, and calculate the loss for 2× and 4× moves.
- Estimate fee yield from recent volume and total liquidity, keeping token incentives separate.
- For concentrated liquidity, check your price range and what happens if the price leaves it.
- Verify pool and token contract addresses, audit reports, and admin powers.
- Record your position against a simple hold benchmark at regular intervals while deposited.
What the formula does not tell you
The impermanent-loss formula assumes a constant-product pool and ignores fees. Real outcomes depend on fee rates, volume, pool design, and gas costs, and future prices cannot be known in advance.
The table is hypothetical. When depositing into a real pool, check the service's latest documentation and pool data with their dates, and calculate outcomes under several price scenarios rather than looking only at the advertised fee yield.