Impermanent Loss

What is an Impermanent Loss?

Impermanent loss is the lost opportunity to profit from an increase in token price since the number of tokens you added in a liquidity pool decreased.

Say, you provided liquidity of 1 ETH and 3200 XYZ in the ETH-XYZ pool when ETH price was $3000. If the ETH price increases and many users swap USDT for ETH on the Decentralized Exchange (DEX), you will end up with 0.8 ETH and more USDT tokens. Let’s assume ETH price is now $4000, you did gain $200 from ETH price rise but lost the opportunity to gain $800 further.

Why does Impermanent Loss Happen?

Decentralized Exchanges (DEX) like Uniswap and SushiSwap provide cryptocurrency exchange services using a process called Automated Market Maker (AMM). AMM-based DEXs will utilize tokens from liquidity pools to facilitate exchanges. So depending on the AMM and market volatility, you’ll lose and gain tokens in the pool. You lose tokens that are in demand and gain the other token in the pair.

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