Providing liquidity can earn trading fees, but a pool can also leave you with a different mix of tokens than you deposited. Impermanent loss measures the resulting gap between your pool position and simply holding the same starting tokens, before fees. Fees may cover that gap; they do not make it disappear or ensure a profit.
What impermanent loss measures
Suppose you deposit two tokens into a pool. To assess impermanent loss later, value both your pool position and your original quantities of those tokens at the same current prices. If the pool position is worth less, the difference is impermanent loss relative to holding. It is not necessarily a loss against the dollars you initially deposited: both the pool position and the held tokens could have risen or fallen in value.
“Impermanent” describes how the comparison can change while you remain in the pool. If the assets’ relative price returns to its entry level, the modeled gap can close. But your token balances and position value change before you withdraw, and neither a price recovery nor enough fee income to cover the gap is assured. Chainlink’s Impermanent loss: What it is and how to manage it | Chainlink offers another introduction to the holding comparison.
Why a pool changes your token balances
In a simplified, full-range, 50/50 constant-product pool, the quantities of the two reserves are represented by x × y = k. When one token becomes more expensive elsewhere, traders can buy it from the pool until the pool’s price moves toward the outside price. The pool then holds less of the token that appreciated relative to its pair and more of the other token. Chainlink’s explainer on impermanent loss describes this arbitrage mechanism.
The fixed k calculation assumes swaps without fees. Real pools collect fees, and deposits and withdrawals also affect reserves. The simple model is useful for understanding the price effect, not for predicting every position’s final value.
A corrected ETH/USDC example
Consider a hypothetical fee-free, full-range 50/50 pool. You deposit 2.5 ETH when ETH costs $2,000, plus 5,000 USDC valued at $1 each. Your starting basket is worth $10,000. If ETH rises to $4,000 while USDC remains at $1, holding the starting tokens would be worth $15,000: $10,000 in ETH plus $5,000 in USDC.
After the pool adjusts to the new price, the simplified position holds about 1.7678 ETH and 7,071.07 USDC. At those prices, it is worth about $14,142.14. The gap to holding is approximately $857.86, or 5.72% of the $15,000 holding value. The pool has still gained value against its $10,000 starting value; it has gained less than holding the original tokens. The example excludes fees, incentives, transaction costs and financing costs.
For a fee-free, full-range 50/50 constant-product position, the same comparison gives about 5.72% underperformance after a 2x relative-price move, roughly 20% after a 4x move, and about 25.46% after a 5x move. These are model outputs, not forecasts. For another explanation of the holding comparison, see impermanent loss calculator. When using a calculator, check that its starting basket, pool design and price-ratio assumptions match the position you are assessing. Impermanent Loss Explained - Binance Academy is a further explanation of the basic holding comparison.
When might fees cover the gap?
Fees depend on trading activity, the pool’s fee tier and the portion of fee-earning liquidity attributable to your position. A 0.3% fee tier with little relevant volume need not pay more than a 0.05% tier with substantial volume. In a concentrated position, whether your liquidity is active also matters. Advertised APR and past volume are starting observations, not future payments.
In the ETH example, fees worth more than $857.86 at the comparison date would cover the modeled gap to holding if there were no other costs. That is a different test from whether the position made money against its $10,000 starting value. For a fuller comparison, value the remaining tokens and earned fees at the same date, then account for incentives, transaction costs and any borrowing interest. Also compare that net result with both the original deposit value and the value of holding the starting tokens. For a general discussion of LP fees and impermanent loss, see Impermanent loss in crypto: Understanding the real risk of providing liquidity - Yahoo Finance.
How pool choice changes the risk
- Stablecoin pairs: Two assets targeting the same value may have a relatively steady price ratio, limiting the usual holding gap. Either asset can depeg, however, and a pool is not protection against issuer, custody or smart-contract risk.
- Correlated pairs: Assets such as ETH and a staked-ETH derivative may often move together, but their relative prices can separate. Check the particular assets and the consequences if the relationship breaks.
- Concentrated liquidity: A narrower price range can put more of your capital to work while the market trades within it. It does not inherently reduce impermanent loss. If the price moves outside the range, the position becomes single-sided and can stop earning fees entirely from swaps while it remains out of range; previously accrued fees remain. Which token you hold depends on the direction of the move. Uniswap’s out-of-range explanation sets out that fee rule, while What is Impermanent Loss - Uniswap Support explains the broader holding comparison.
- Single-sided deposits and managed vaults: A simpler deposit process does not establish that the underlying strategy avoids paired-asset exposure. Check how deposits are converted, how positions are adjusted, what fees apply and which contract or manager risks you take on.
Research also examines ways to change these trade-offs. A modeled gap of 20% is one scenario, not a universal outcome. IACR paper on AMM impermanent loss (2026) surveys impermanent-loss models and mitigation approaches; the paper does not establish the percentages in the example above or make any pool design risk-free.
A decision checklist before depositing
- Define the comparison. Record the quantities you would otherwise hold and the period over which you will compare outcomes.
- Test relative-price moves. Ask what happens if either asset becomes more expensive than the other, including if a peg or expected correlation breaks.
- Inspect fee conditions. Look at the fee tier, relevant trading volume, your share of active liquidity and how long you expect to remain in the pool. Do not treat historical volume as a promise.
- Count other costs and risks. Include transaction costs, incentive-token price changes, contract risk and any cost of financing the deposit.
- Check the exit position. Understand which tokens you might receive if you withdraw after a large price move or after a concentrated position leaves its range.
If you consider borrowing against existing crypto to fund a separate position, assess the loan and the pool independently. Borrowing can preserve your original crypto holding, but it adds interest, collateral and liquidation risk, as well as protocol risk; it does not change the pool’s impermanent-loss mechanics. Compare borrowing with selling before assuming either suits your circumstances. Seeing holdings, debt and position value together can help frame questions for OverseasDeFi’s portfolio-aware AI coach and live guidance, but those tools cannot prevent losses or make the decision for you. The learning hub covers related concepts.
FAQ
Is impermanent loss a loss of my initial deposit?
Not necessarily. It is underperformance against holding the same starting tokens, measured at the same later prices before fees. Your pool position can be up or down against the dollars you deposited.
Do fees erase impermanent loss?
Fees can offset or exceed the holding gap, but the underlying change in token balances still occurred. Compare the value of your position and fees with both the holding basket and your starting value, after costs.
Does staying in a pool long enough fix the gap?
No. The relative price might return to its entry level, but it might not. More time can bring more fees and more exposure to price changes and contract risk.
Does concentrated liquidity reduce impermanent loss?
Not by itself. A narrow range changes how your capital is exposed to price moves and when it earns new swap fees. Model the chosen range and possible out-of-range holdings rather than assuming higher fee potential means lower risk.
Why is my pool position falling in dollar value?
One or both tokens may have fallen in price. Your position may also trail the value of holding the starting tokens, even if it has risen in dollars. Check token balances, current prices, earned fees and costs separately to identify which changes matter.