Impermanent Loss

Impermanent Loss Risk

If you’ve been involved with DeFi at all, you almost certainly heard this term thrown around. Impermanent loss happens when the price of your tokens changes compared to when you deposited them in the pool. The larger the change is, the bigger the loss.

What is impermanent loss?

Impermanent loss happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them. The bigger this change is, the more you are exposed to impermanent loss. In this case, the loss means less dollar value at the time of withdrawal than at the time of deposit.

Pools that contain assets that remain in a relatively small price range will be less exposed to impermanent loss. Stablecoins or different wrapped versions of a coin, for example, will stay in a relatively contained price range. In this case, there’s a smaller risk of impermanent loss for liquidity providers (LPs).

So why do liquidity providers still provide liquidity if they’re exposed to potential losses? Well, impermanent loss can still be counteracted by trading fees. In fact, even pools on Uniswap that are quite exposed to impermanent loss can be profitable thanks to the trading fees.

For example, Uniswap charges 0.30% on every trade that directly goes to liquidity providers. If there’s a lot of trading volume happening in a given pool, it can be profitable to provide liquidity even if the pool is heavily exposed to impermanent loss. This, however, depends on the protocol, the specific pool, the deposited assets, and even wider market conditions.

Read more: https://academy.binance.com/en/articles/impermanent-loss-explained

Impermanent Loss Explained

Watch a Video Explainer: https://www.youtube.com/watch?v=8XJ1MSTEuU0