Impermanent loss is the difference between the value of assets you deposit into an automated market maker (AMM) liquidity pool and the value you would have if you simply held those assets in your wallet. It most commonly affects liquidity providers (LPs) on decentralized exchanges (DEXs) when the price of one token in a pair moves relative to the other.
How impermanent loss happens in AMM pools
In AMM-based DEXs, pools are typically designed to keep a mathematical balance between two assets. When traders buy one asset from the pool and sell the other into it, the pool’s composition shifts. As prices move, the pool ends up holding more of the asset that has fallen in relative value and less of the asset that has risen. This rebalancing is what creates impermanent loss compared with holding, even if the total dollar value of the pool position may still increase.
The loss is called “impermanent” because it is not realized until you withdraw. If the relative price returns to where it was when you deposited, the gap versus holding can shrink or disappear. If the price movement persists, the loss can become effectively permanent at withdrawal.
Practical context, fees, and why LPs still participate
Consider an LP providing equal values of Token A and Token B. If Token A appreciates significantly versus Token B, a simple holder benefits fully from the rise. The LP, however, will have less Token A and more Token B after arbitrage and trading rebalance the pool, which can leave them behind the holder’s outcome.
LPs accept this risk because they earn trading fees, and sometimes additional incentives, which can offset impermanent loss. Understanding impermanent loss matters because it is a core risk of DeFi liquidity provision, shaping how users choose pools, assess volatility, and evaluate whether fee income compensates for price movement.