Impermanent Loss Explained: Why Your LP Position Underperformed

The short answer: impermanent loss is how much an LP position trails simply holding the same two assets, and it depends only on how far their price ratio moves — a 2× divergence costs 5.7%, a 4× costs 20% — with trading fees the only thing that can close the gap.

You provided liquidity, the pool “earned fees,” both tokens went up — and somehow you’d have more money if you had just left the coins in a wallet. That gap has a name, a formula, and a curve, and once you’ve seen the numbers it stops being mysterious. This guide walks the whole thing with a table you can sanity-check against our impermanent loss calculator.

What a 50/50 pool actually does

A constant-product pool (Uniswap v2 and its descendants) holds two assets and rebalances continuously so each side keeps equal dollar value. When token A rises against token B, arbitrageurs buy A out of the pool until prices match the wider market — which means the pool systematically sells your winner and accumulates your laggard. That’s not a bug; it’s what makes the pool quote prices at all. But it has a cost: your deposit grows at the geometric mean of the two assets’ growth, while a wallet grows at the arithmetic mean, and the geometric mean is never the larger one.

The divergence table

Only the price ratio between the two assets matters. With r as the ratio change and IL = 2√r ÷ (1 + r) − 1:

Ratio change	Example move	Loss vs. holding
1.1×	+10% / 0%	−0.11%
1.25×	+25% / 0%	−0.62%
1.5×	+50% / 0%	−2.02%
2×	+100% / 0%	−5.72%
3×	+200% / 0%	−13.40%
4×	+300% / 0%, or +100% / −50%	−20.00%
5×	+400% / 0%	−25.46%
10×	+900% / 0%, or +150% / −75%	−42.50%
∞	one asset → 0	−100%

Three things to notice. The curve is flat near 1× — small wobbles cost basis points, which is why market-neutral pairs work. It steepens brutally: doubling the divergence from 2× to 4× more than triples the loss. And direction is irrelevant — +300%/0% and +100%/−50% are both a 4× ratio and both cost exactly 20%.

Why “impermanent”?

Because the loss is only locked in when you withdraw. If the ratio returns to where you entered, the loss shrinks back to zero — the pool buys back your winner on the way down. That’s the honest meaning of the name, and also its marketing spin: in practice, pairs that diverge often stay diverged, and a loss you’re waiting out is still capital you can’t redeploy.

Fees: the other half of the ledger

Nobody LPs for fun; they LP for the fee stream, and the position’s real P&L is fees earned − impermanent loss. That turns the table above into a hurdle rate. If your pair historically diverges about 2× over a year, the pool needs to pay roughly 5.7% in fee APR just to break even with holding — anything advertised below that is a structurally losing trade dressed up with yield. High-volume stable pairs clear their (tiny) hurdle easily; exotic volatile pairs with 3% fee APR usually don’t clear theirs.

Two refinements worth knowing:

1. Concentrated liquidity (Uniswap v3) amplifies both sides. Inside your chosen range you earn more fees per dollar and suffer amplified divergence loss; outside it you hold 100% of the losing asset. Treat the classic full-range numbers above as the floor of what divergence can cost there.
2. Reward tokens are fees with extra steps. Liquidity-mining emissions can bridge the IL gap, but they add a second volatile asset to your P&L — value them at what you actually sell them for, not at the dashboard APR.

The stablecoin special case

Two pegged assets have a ratio pinned near 1×, so IL sits near zero — that’s why stable-stable pools can run enormous volume on hair-thin fees and still pay LPs. The catch is the tail: a depeg is precisely the “one asset goes toward zero” row of the table. If you LP stables, the yield is real but the risk is binary; our stablecoin yields page tracks what the honest end of that market pays without LP risk at all.

A worked example

Deposit $1,000 into an ETH/USDC pool. ETH doubles; USDC holds. Holding would give you $1,500 (your $500 of ETH doubled). The pool gives you $1,414 — the geometric mean √2 × $1,000. The gap, $86, is the 5.72% from the table. If the pool paid you $120 of fees along the way, you beat holding by $34; if it paid $50, LPing cost you $36 despite “earning yield” the whole time. Run your own entry with the impermanent loss calculator — it shows the loss in dollars and the full curve — and pressure-test the yield side with the compound interest calculator.