Impermanent loss (IL) is one of the most misunderstood concepts in DeFi. It's not a fee, not a hack, and not always a loss — but it can silently eat your returns if you don't account for it.
What Impermanent Loss Is
When you deposit two tokens into an AMM like Uniswap or Orca, arbitrageurs rebalance your position when prices shift. You end up with a different ratio of tokens than you deposited, at a less favorable composition than simply holding both.
The "loss" is the difference between your LP position and a simple hold of the same assets. It's called impermanent because if prices return to the original ratio, the loss disappears.
A Concrete Example
Deposit into ETH/USDC pool: 1 ETH ($3,000) + 3,000 USDC = $6,000.
ETH doubles to $6,000. After rebalancing:
- LP position: ~0.707 ETH + ~4,243 USDC ≈ $8,485
- Simple hold: 1 ETH + 3,000 USDC = $9,000
- Impermanent loss: ~$515 (5.7%)
You still gained — just less than holding.
The IL Formula
For constant-product AMMs: IL = 2√r / (1 + r) - 1 where r = new price / original price.
| Price change | IL | |---|---| | 2× | -5.7% | | 4× | -20% | | 10× | -42% | | 0.5× | -5.7% |
When IL Hurts Most
Volatile pairs (SOL/USDC, ETH/USDC): Large price swings cause large IL.
Correlated pairs (SOL/mSOL, ETH/stETH): Both assets move together; IL stays low.
Concentrated liquidity (CLMM): Amplifies both fees and IL when price exits your range.
When LP Rewards Overcome IL
High volume generates enough fees to exceed IL. Stablecoin pairs (USDC/USDT) have near-zero IL with real fee yield. Long holding periods with consistent volume often favor LPing.
Rules of thumb:
- Stable pairs: LP freely if APY covers gas
- Correlated LST pairs: Low IL, watch the peg
- Volatile single-sided pairs: Calculate break-even fee APY before committing