Impermanent loss: compare providing liquidity with holding

The short version

Impermanent loss compares what your liquidity-pool position is worth with what the same starting assets would be worth if you had simply held them. In some automated-market-maker pools, trading rebalances the assets you own through the pool as their relative prices change. The position can therefore underperform the hold-only comparison, even if its dollar value has risen. Uniswap's protocol glossary defines the term as this opportunity cost; it is not a prediction that a position will recover.

One simplified 2× price example

Start with 1 ETH at $2,000 and $2,000 USDC: $4,000 total. Compare two choices using the same starting assets. The diagram follows a fee-free, 50/50 constant-product pool and assumes trading brings the pool price in line with an outside market price. This is one simplified model, not every automated market maker.

If ETH rises to $4,000, the hold-only portfolio is still 1 ETH plus $2,000 USDC, worth $6,000. In the pool, traders buy ETH from its reserves, so the position holds less ETH and more USDC. Under the constant-product example, it ends near 0.7071 ETH plus $2,828.43 USDC, worth about $5,656.85. That is about $343.15, or 5.7%, below the hold-only value at this endpoint. The pool position is still worth more than its $4,000 starting value: the 5.7% describes relative underperformance, not a 5.7% loss of the starting principal.

Uniswap's v2 return guide derives this comparison for its constant-product model. The assumptions matter: the example excludes fees, gas, taxes and rewards, and is not a forecast. A pool can earn fees yet still trail holding.

Pool design and fees change the comparison

The amount depends on pool design, price path and position parameters. The constant-product formula x × y = k describes early Uniswap versions; it is not a universal rule for every pool. Concentrated-liquidity positions add price ranges and management decisions. Uniswap's fee documentation notes that fee handling differs by version. Fees or rewards may offset some relative underperformance, but do not guarantee a better result. Contract failure, token risk, administrator powers and withdrawal conditions are separate risks, not part of the arithmetic above.

For a useful benchmark, compare the pool position with the same starting assets, valuation currency and endpoint. Keep fee income and rewards separate from the change caused by rebalancing. One endpoint also cannot describe every price path along the way. For how pool reserves and swaps work, see DEX liquidity pools and what decentralized finance means.

A no-money review

• Name the pool model and the assumptions behind any calculator.
• Compare with holding the same starting assets—not with cash or a different portfolio.
• Record fees and rewards separately; check the position's range and withdrawal rules.
• Treat an audit, popular interface or large deposited balance as evidence with limits, not as insurance.

Do not read “impermanent” as harmless or automatically reversible. A price relationship may never return to its starting point, and withdrawing can crystallize the relative outcome. Learning does not require depositing assets, granting approvals or using leverage; this guide does not recommend a protocol.