Impermanent Loss

Understanding the Nuances

At its core, Impermanent Loss, sometimes referred to as Divergent Loss, describes the potential cost or opportunity cost of adding liquidity to an Automated Market Maker (AMM) pool compared to simply holding the individual tokens.

1. Causes and Dynamics

This form of loss is caused by a difference in the price performance of two assets within the pool. It is important to understand the nuances here:

  • No Divergence: If both assets in the pool amplify their value by, say, 20%, the impermanent loss remains non-existent.

  • Divergence: However, if one asset skyrockets by 20% while the other remains static, a divergence has happend. This differential leads to impermanent loss in the pool position.

2. Reversion Possibilities

The name "impermanent" implies that the situation isn't static. The loss can potentially revert:

  • Convergence: If the previously static token also experiences a 20% hike, or both tokens align their price movement to the initial pooled ratio, the impermanent loss vanishes.

3. Impermanent Loss in Action: An descriptive Scenario

Let's look at a simple case to get to the nuances of it:

Assume you have two assets, A and B, in a pool. You initiate with equal values of both. If Asset A's value hikes by 20% and Asset B remains unchanged, you experience impermanent loss. However, if subsequently, Asset B also sees a 20% appreciation, or both A and B adjust their price trajectories to return to the original pooled proportion, the impermanent loss vanishes. IL=PoolValue/HodlValue1IL = PoolValue/HodlValue - 1

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