Impermanent loss refers to the potential loss a liquidity provider experiences when the prices of the two tokens in a liquidity pool diverge from their initial ratio. It is called “impermanent” because the loss only becomes permanent if the assets are withdrawn before the prices return to their original ratio. This phenomenon occurs in automated market maker (AMM) systems such as Uniswap, where arbitrage trading adjusts pool balances. Even with high yields, impermanent loss can erode profits, making it crucial to estimate its impact before investing. This calculator helps quantify that risk in a simple and reliable way.
Detailed Explanations of the Calculator’s Working
The Impermanent Loss Calculator works by taking the ratio of the current price of a token pair relative to their original value when added to the liquidity pool. The tool then uses a mathematical formula based on the constant product (x*y=k) AMM model to estimate potential loss. Users input the price ratio (new price divided by old price), and the calculator returns the percentage of value lost due to the price divergence. This result represents the theoretical loss a provider would incur compared to simply holding the two tokens outside the pool. It’s essential for yield optimization and portfolio planning.
Formula with Variables Description
Where:
- IL = Impermanent Loss (as a decimal, can be converted to % by multiplying by 100)
- Price Ratio = New price of Token A / Old price of Token A
- The result expresses how much less value a liquidity provider has compared to holding the tokens independently.
Reference Table: Price Ratios vs. Impermanent Loss %
| Price Ratio (A/B) | Impermanent Loss (%) |
|---|---|
| 1.00 | 0.00% |
| 1.25 | 0.60% |
| 1.50 | 2.00% |
| 2.00 | 5.72% |
| 3.00 | 13.40% |
| 4.00 | 20.00% |
| 5.00 | 25.46% |
Use this table to get a quick estimate of impermanent loss for common token price divergences.
Example
Imagine you provide liquidity to a pool with ETH and USDC when ETH is priced at $2,000. Later, ETH rises to $4,000. The price ratio becomes 2.0.
Using the formula:
IL = 2 × √2 / (1 + 2) - 1
≈ 2 × 1.4142 / 3 - 1
≈ 0.9428 - 1
≈ -0.0572 or -5.72%
This means you would have 5.72% less value than if you had just held your ETH and USDC without providing liquidity.
Applications
Decentralized Finance (DeFi) Liquidity Pools
Traders and investors use this calculator to estimate risk before contributing assets to DeFi liquidity pools on platforms like Uniswap, Curve, or Balancer.
Risk Assessment for Yield Farming
Yield farmers can compare potential rewards versus impermanent loss using the calculator to make strategic investment decisions and avoid high-divergence pools.
Portfolio Performance Comparison
By comparing returns from holding tokens directly vs. participating in LPs, investors can optimize strategies for long-term performance and risk-adjusted gains.
Most Common FAQs
Impermanent loss occurs when the price of tokens in a liquidity pool diverge from their original deposit ratio. It’s important to calculate because it can reduce the value of your assets even when yields appear high. Estimating this loss allows you to understand if the rewards from providing liquidity justify the associated risks.
Yes, if you withdraw your assets from the liquidity pool while prices are still divergent, the loss becomes permanent. If prices return to their original state, the loss may disappear. However, since market conditions fluctuate, it’s risky to assume full recovery, making early evaluation crucial.
You can reduce risk by selecting pools with low price volatility, using stablecoin pairs, or joining protocols that offer IL insurance or incentives. Proper strategy, calculator analysis, and smart diversification are also essential in managing exposure effectively.