What Is Impermanent Loss in DeFi? (Explained Without the Math Headache)

If you've ever looked at providing liquidity on Uniswap, Raydium, or any other DEX, you've probably seen the warning about impermanent loss. Most people read it, don't understand it, and deposit anyway. Then three months later they withdraw and realize they would have made more money just holding the tokens.

That gap between what you earned as an LP and what you would have earned by holding is impermanent loss. And it's one of the most misunderstood concepts in all of DeFi.

The Simple Explanation

When you provide liquidity to a DEX pool, you deposit two tokens in equal value. Let's say you put $5,000 of ETH and $5,000 of USDC into the ETH/USDC pool on Uniswap. Total deposit: $10,000.

Now imagine ETH doubles in price. Great news, right? Well, sort of. If you had just held your ETH, your $5,000 of ETH would now be worth $10,000, plus you still have $5,000 USDC. Total: $15,000.

But as an LP, the pool automatically rebalances your position. As ETH's price rises, the pool sells some of your ETH for USDC to maintain the 50/50 ratio. When you withdraw, you end up with less ETH and more USDC than you started with.

Your withdrawal might be worth $14,100 instead of the $15,000 you would have had by just holding. That $900 difference is impermanent loss.

Wait, $14,100 is still more than your original $10,000, so you still made money. True. But you made $900 less than you would have by doing nothing. That's the loss. It's the opportunity cost of being an LP instead of a holder.

Why Is It Called "Impermanent"?

Because if the price returns to the original ratio when you deposited, the loss disappears. If ETH goes back to exactly the price it was when you entered the pool, you get back the same amount of each token you deposited. No loss.

The problem is that prices rarely return to exactly where they were. And the longer a price moves in one direction, the worse impermanent loss gets. The "impermanent" part is technically accurate but practically misleading. In reality, for most LPs, the loss is very permanent because they withdraw before prices revert.

Some DeFi people have started calling it "divergence loss" instead, which is honestly a better name. The loss comes from the price of the two tokens diverging from each other.

When Impermanent Loss Gets Brutal

The loss isn't linear. It accelerates as the price moves further from your entry point. Here's a rough scale:

• Price changes 25% from entry: about 0.6% impermanent loss
• Price changes 50%: about 2% loss
• Price changes 100% (doubles): about 5.7% loss
• Price changes 200% (triples): about 13.4% loss
• Price changes 500%: about 25.5% loss

So if you're providing liquidity for a volatile small cap token that 5x's, you're looking at losing about a quarter of the value you would have had by just holding. That's massive. And it gets worse on the downside too. If one token crashes 80%, impermanent loss is around 20%.

This is why providing liquidity for volatile token pairs is so risky. The fees you earn need to exceed the impermanent loss, and for many pools, they don't.

Real World Example: The ETH/SHIB Disaster

Back in mid 2025, a lot of people provided liquidity in ETH/SHIB pools because the APY looked incredible. Some pools were showing 200%+ APY. Looked like free money.

Then SHIB dropped 70% against ETH over three months. LPs suffered roughly 15% to 20% impermanent loss. The trading fees they earned covered maybe 8% of that. Net result: they would have been better off just holding ETH.

Some LPs stuck around hoping SHIB would recover and the loss would become "impermanent" again. It didn't. They eventually withdrew at a significant loss compared to just holding.

The high APY was high precisely because the risk of impermanent loss was high. The market was pricing in the risk. Most LPs didn't realize they were being compensated for a real risk that actually materialized.

When Impermanent Loss Doesn't Matter (Much)

Not all LP positions are equally exposed. Some situations make impermanent loss much less of a concern.

Stablecoin pairs. Providing liquidity for USDC/USDT or DAI/USDC carries almost zero impermanent loss because both tokens maintain a 1:1 peg. Price divergence is minimal. The yields are low (3% to 8% typically) but the risk is also low. This is the safest LP strategy in DeFi.

Correlated asset pairs. Pools like stETH/ETH (staked Ethereum vs regular Ethereum) experience very little impermanent loss because the two tokens track each other closely. Same for wBTC/BTC pools.

Short time frames with high volume. If a pool generates massive trading fees (high volume relative to liquidity), the fees can more than offset impermanent loss even on volatile pairs. But this is rare for retail LPs because the best pools are usually saturated with liquidity from professional market makers.

Concentrated liquidity positions that you actively manage. On Uniswap V3, you can provide liquidity within a specific price range. If you actively manage your range and adjust as prices move, you can reduce impermanent loss. But this requires constant attention and isn't passive income at all.

How to Minimize Impermanent Loss

You can't eliminate it entirely (it's a fundamental property of AMM design), but you can reduce it significantly.

Stick to less volatile pairs. The more the prices of the two tokens diverge, the worse IL gets. Pairs where both tokens move similarly (ETH/stETH, BTC/wBTC, USDC/USDT) have minimal IL.

Consider the fees. Before entering any LP position, calculate whether the expected fees will exceed the expected impermanent loss. Pools with high daily volume relative to their TVL generate more fees per LP dollar. Look for pools where daily volume is at least 10% to 20% of TVL.

Use concentrated liquidity carefully. Uniswap V3 style concentrated liquidity lets you earn more fees by providing liquidity in a narrow price range. But if the price moves outside your range, you stop earning fees entirely and your impermanent loss is worse than a standard full range position. It's a double edged sword.

Set time limits. Don't provide liquidity indefinitely. Go in with a plan. "I'll LP for 30 days and withdraw if IL exceeds fees by more than 3%." Having a clear exit strategy prevents the slow bleed that catches most LPs.

Check IL calculators. Tools like dailydefi.org and ImpermanentLoss.net let you input a pool and time period and see your actual impermanent loss. Use them before you deposit and while you're in the pool.

The Uncomfortable Math

Here's what most DeFi yield farmers don't want to hear. A study by Bancor in 2021 found that about 50% of LPs on Uniswap V3 would have been better off just holding their tokens. More recent analysis from late 2025 suggests that number hasn't improved much.

Half of all liquidity providers are losing money compared to just holding. And these are people who thought they were earning yield. They were, technically. But the impermanent loss ate more than the yield gave.

Providing liquidity is not passive income. It's a specific trading strategy with real risks. Treat it that way. Understand what you're signing up for, calculate the numbers before you deposit, and don't chase APY numbers that look too good to be true. They usually are, and impermanent loss is usually the reason why.