Impermanent Loss Explained: The Hidden Cost of Providing Liquidity
Why liquidity providers underperform holders when prices diverge, how big the loss gets, and when fees make up for it.
The mechanism in one paragraph
Automated market makers price assets by keeping a mathematical balance between the two sides of a pool. When one asset rises against the other, arbitrage traders rebalance the pool ā buying the cheap side from it, selling the expensive side to it ā which leaves liquidity providers holding progressively less of the winner and more of the loser. Compared with simply holding both assets, the LP position lags. That lag is impermanent loss.
How big it gets
The loss depends only on how far the price ratio moves: a 1.25Ć divergence costs about 0.6%, 2Ć costs 5.7%, 4Ć costs 20%, and a 10Ć move costs over 42% versus holding. Two properties follow: IL is symmetric (it doesn't matter which asset moved), and it's brutal for volatile pairs while nearly zero for assets that track each other ā which is why stablecoin pools dominate cautious strategies.
Why 'impermanent', and when it isn't
If prices return to the ratio at which you deposited, the loss evaporates ā hence the name. But the name flatters the reality: you realise whatever gap exists at the moment you withdraw. Providing liquidity to a pair that trends apart permanently converts 'impermanent' into 'very permanent'.
The real question: do fees cover it
LPs earn trading fees, and that's the entire bet: fee income versus divergence loss. Busy pools with modest volatility can win comfortably; quiet pools of volatile assets almost never do. Before depositing, run your realistic divergence scenario through the calculator below ā the number it returns is the hurdle your fees must clear. Most disappointed liquidity providers never checked.