Understanding Impermanent Loss in Automated Market Maker Pools
Summary
The guide explains how impermanent loss arises when the relative prices of two tokens change while they are held in an automated market maker (AMM) liquidity pool. It contrasts a liquidity position with simply holding the deposited assets, describes how swaps and arbitrage move a pool toward market prices, and illustrates how a provider’s token mix can change as a result. Trading fees may offset some or all of the opportunity cost, so the position’s return depends on both price changes and rewards.
A meaningful assessment requires deposit and withdrawal prices, amounts, dates, pool fees, and any yield earned by using LP tokens elsewhere. The guide emphasizes that estimates can miss additional strategies and intraday deposits or withdrawals, and that risk varies by token pair. Its examples are simplified explanations rather than a complete evaluation method; it gives no general forecast or guarantee that fees will compensate for losses.
Key ideas
- Impermanent loss compares a liquidity position with holding the original tokens outside the pool.
- Relative price changes cause the pool to rebalance its token quantities as arbitrage aligns pool prices with broader markets.
- Trading fees and other LP-token yields can offset impermanent loss, so they belong in a total-return assessment.
- A position-level calculation needs deposit and withdrawal details as well as fee and yield information.
- Risk differs across token pairs and can be harder to assess when positions change during the measurement period.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.