📌 Impermanent Loss Summary
Impermanent loss is a temporary reduction in the value of funds provided to a decentralised finance (DeFi) liquidity pool, compared to simply holding the assets in a wallet. This happens when the prices of the pooled tokens change after you deposit them. The bigger the price shift, the larger the impermanent loss. If the token prices return to their original levels, the loss can disappear, which is why it is called impermanent. However, if you withdraw your funds while prices are different from when you deposited, the loss becomes permanent.
🙋🏻♂️ Explain Impermanent Loss Simply
Imagine you and a friend each put £10 into a box, one in chocolate bars and one in crisps, expecting them to always be worth the same. If the price of chocolate suddenly jumps but you both have to split the box evenly, you lose out compared to if you had just kept your chocolate. This is similar to impermanent loss in liquidity pools, where price changes can mean you get less value back than if you had just held your tokens.
📅 How Can it be used?
A DeFi app could warn users about potential impermanent loss when they add funds to a liquidity pool.
🗺️ Real World Examples
A user provides equal values of Ethereum and USDC to a Uniswap trading pool. If Ethereum price rises significantly while their assets are locked, they may end up with less Ethereum than they started with when they withdraw, leading to impermanent loss compared to simply holding Ethereum.
A small business adds its own token and a stablecoin to a decentralised exchange to help with trading. If the business token drops in value, the business could end up with more of its own token and less stablecoin, resulting in impermanent loss relative to holding both assets.
✅ FAQ
What is impermanent loss in DeFi liquidity pools?
Impermanent loss is when the value of your crypto in a liquidity pool temporarily drops compared to just holding the same coins in your wallet. This happens if the prices of the coins in the pool change after you deposit them. If the prices go back to where they started, the loss can go away, which is why it is called impermanent.
Can you avoid impermanent loss when providing liquidity?
It is hard to completely avoid impermanent loss if the prices of the pooled coins change a lot. The risk is always there if the tokens do not move in sync. Some pools with more stable coins or tokens that tend to move together can have less impermanent loss, but it cannot be removed entirely.
When does impermanent loss become permanent?
Impermanent loss only becomes permanent if you withdraw your money from the liquidity pool while the token prices are still different from when you first deposited. If you leave your funds and the prices return to their original levels, the loss can disappear.
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