Impermanent Loss in Automated Market Maker Liquidity Pools
Summary
Impermanent loss is the reduction in a liquidity provider’s pool value relative to simply holding the deposited assets. The document explains the setting: an automated market maker holds two assets in a smart-contract pool, and traders’ swaps change their quantities as market prices move. Liquidity providers make those assets available for trading and cannot freely use them elsewhere while they remain committed to the pool.
The comparison is driven by price changes and the pool’s rebalancing mechanism, so the assets’ value in the pool can diverge from the value of holding the original tokens. The text offers a basic definition and mechanism, but no formula, worked example, fee analysis, or empirical evidence. It also does not quantify how trading fees or other pool designs may affect the outcome, so it is an introductory explanation rather than a complete framework for evaluating liquidity provision.
Key ideas
- Impermanent loss compares a liquidity provider’s pool value with the value of holding the deposited assets.
- AMMs use pools of tokens to facilitate swaps without a traditional central order book.
- Trades change the quantities of each token held by the pool.
- Price movement and pool rebalancing can make pool holdings worth less than a passive hold.
- Assets committed to a pool are locked in a smart contract and unavailable for other trades while deposited.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.