Impermanent Loss: The Silent Killer of Yield Farmers
Impermanent Loss is the hidden cost of providing liquidity to an AMM. Learn why holding a token is often more profitable than putting it in a liquidity pool.
Impermanent Loss
Impermanent Loss (IL) is the difference in total portfolio value between holding two assets passively in your wallet versus depositing those same two assets into an Automated Market Maker (AMM) liquidity pool.
Whenever the price of the assets in a liquidity pool diverges significantly from the price at which you deposited them, you suffer impermanent loss.
Why Yield Farming Can Make You Poorer
Many traders flock to AMMs like Raydium or Uniswap to provide liquidity (LPing) because the exchange promises massive yields (e.g., 200% APY in trading fees). However, they ignore the mathematical reality of the x * y = k pricing curve.
The Setup:
- You provide liquidity to the
SOL / USDCpool. You deposit 10 SOL (worth $1,000 at $100/SOL) and 1,000 USDC. Total value = $2,000. - The price of SOL skyrockets 100% on external markets (Binance, Coinbase) to $200.
The Arbitrage Drain: Because your AMM pool is still pricing SOL at $100, arbitrage bots rush in. They buy the cheap SOL from your pool and sell it for $200 on Binance. As they buy SOL from the pool, they remove SOL and add USDC. The pool’s internal ratio shifts.
The Result: When you withdraw your liquidity from the pool, you no longer get back your original 10 SOL and 1,000 USDC. Instead, the math dictates you receive roughly 7.07 SOL and 1,414 USDC.
- Value if you just HODLed: (10 SOL * $200) + 1,000 USDC = $3,000.
- Value of your LP withdrawal: (7.07 SOL * $200) + 1,414 USDC = $2,828.
You lost $172 simply because you provided liquidity. This deficit is the “Impermanent Loss.”
Why is it called “Impermanent”?
It is called impermanent because if the price of SOL eventually returns exactly back to $100 (your deposit price), the loss disappears and the pool ratio resets to your original 10 SOL and 1,000 USDC.
However, the moment you click “Withdraw Liquidity” while the prices are diverged, the loss becomes permanent and realized. If the trading fees you earned during that time do not exceed the $172 IL, providing liquidity was a net negative trade compared to simply holding the assets in your wallet.
Related Terms
- AMM vs Order Book — Why AMMs suffer from IL but CLOBs do not.
- Price Impact — The mathematical force driving the arbitrage that causes IL.
- Slippage — The friction incurred when trading against the pool.