Definition
Impermanent loss is a pricing effect that occurs when assets deposited into an automated market maker (AMM) liquidity pool diverge in price relative to when they were deposited. It measures how much less a liquidity provider’s position is worth compared to just passively holding the same tokens outside the pool. The loss is called “impermanent” because it can shrink or disappear if relative prices move back toward their original levels. It becomes effectively permanent when the liquidity provider withdraws their assets while the price difference still exists.
This concept is central to understanding risk for liquidity providers in decentralized finance protocols that use AMM designs. Impermanent loss arises from the way AMMs rebalance token reserves to maintain their pricing formulas as market prices change. It is distinct from trading fees or token rewards that may offset or exceed the loss, and it does not refer to a protocol failure or exploit. Instead, it is an inherent economic outcome of providing liquidity under volatile price conditions.
Context and Usage
Impermanent loss is most commonly discussed in the context of DeFi platforms where users supply token pairs to AMM-based liquidity pools. Protocols such as Maker, Compound, GMX, and others may interact with or build on top of AMM liquidity, making awareness of impermanent loss important for understanding the broader DeFi ecosystem. The term is used as a risk metric to describe how exposure to pool rebalancing differs from simple asset holding.
In practice, impermanent loss is referenced when evaluating the economic profile of providing liquidity versus alternatives such as staking or lending. It highlights that liquidity providers are effectively taking on a specific type of price exposure created by the AMM’s design. The concept does not describe a guaranteed outcome but a potential value gap that depends on how much relative prices move while assets remain in the pool.