Impermanent loss happens when the value of your crypto tokens in a liquidity pool drops compared to just holding them in your wallet. This loss appears if the prices of the tokens change from when you first deposited them.
Most decentralized exchanges use automated market makers to balance two or more tokens in a pool. When traders swap tokens, the AMM adjusts the token amounts to follow the pool’s pricing rule. If one token’s price changes a lot compared to the other, the pool shifts your share so you end up with more of the token that lost value and less of the one that gained. This can leave you with less total value than if you had just held your original tokens.
This loss is called impermanent because it can go away if token prices return to where they were when you first added liquidity. Then, the pool rebalances and your withdrawal value matches what you would have had by just holding. But if prices don’t return and you withdraw while the difference remains, the loss becomes permanent.
Imagine you add two tokens to a pool with equal dollar value. Later, one token doubles in price while the other does not move. The pool automatically shifts your share toward the token that did not rise as much. Because of that shift, your total holding ends up worth less than if you had simply kept both tokens outside the pool. If the fast-moving token falls back to its original price before you withdraw, the earlier shrinkage can vanish.
People use different strategies to reduce the risk of impermanent loss. One way is to provide liquidity to pairs that don’t change much in price, like stablecoin pairs. Another is to choose pools that offer higher trading fees or extra rewards, which can help make up for losses. Some platforms also offer protections like impermanent loss insurance or special reward programs. Spreading your funds across different pools and watching the market can also help balance the rewards and risks.
If you withdraw your tokens from a pool while there is still a price difference between them, the loss becomes permanent and can’t be undone by later price changes. But if you stay in the pool and prices move back toward your original deposit levels, your value is restored compared to just holding. The timing of your withdrawal is what decides if the loss is permanent.
Before you add funds, weigh the expected fee income and any extra rewards against how much the token pair’s price might change. Pools with high rewards can cover temporary losses, but they usually have more risk. If you want to avoid price swings, it may be better to provide liquidity to two stablecoins instead of a pair with a volatile token. Looking at a pool’s past data can help you guess how often rebalancing will change your asset mix.
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