Impermanent Loss: What It Is and How It Affects Crypto Liquidity Providers

When you supply assets to a DeFi, a decentralized finance system that lets users lend, borrow, and trade without banks. Also known as decentralized finance, it operates through smart contracts and automated market makers (AMMs). You’re not just holding crypto—you’re helping others trade it. But there’s a catch: impermanent loss, the temporary drop in value you experience when the price of your deposited tokens changes compared to when you added them. It’s called "impermanent" because if prices return to their original levels, the loss disappears. But if they don’t, it becomes real. This isn’t a bug—it’s how AMMs work.

Every time you join a liquidity pool, you’re paired with another token—like ETH and USDC. The system keeps the total value of your deposit balanced using a formula. But if one token’s price spikes or crashes, the protocol automatically sells some of the gaining asset and buys more of the falling one to maintain balance. That means you end up holding more of the cheaper token and less of the one that rose. Even if the overall market value goes up, your share of the pool might be worth less than if you’d just held the tokens in your wallet. That’s impermanent loss in action. It’s why some providers lose money even when the market is up. The bigger the price swing, the worse the loss. And while liquidity providers earn trading fees and sometimes extra token rewards, those don’t always cover the gap.

Some people treat liquidity provision like passive income. But it’s not. It’s a trading strategy with hidden risks. You’re essentially selling high and buying low—without control over timing. The best way to reduce exposure? Stick to stablecoin pairs like USDC/DAI, where price swings are tiny. Or use protocols that offer insurance or dynamic fee structures. Know your assets. Know your pool. Know your risk. The posts below break down real cases, tools to calculate your exposure, and how top providers manage this risk in 2025. You’ll find clear examples, step-by-step guides, and honest talk about what works—and what doesn’t—when you’re on the other side of the AMM.