Impermanent Loss (IL)

What Is Impermanent Loss?

Impermanent loss is one of the risks involved when engaging with yield farming in a decentralised finance (DeFi) protocol. It occurs when there is a change in the token price of the deposited assets: The larger the difference, the more risk to loss is exposed. In such an event, an actualised loss would mean having a lesser total dollar value at the time of withdrawal from the liquidity pool than at the time of deposit. 

For that reason, liquidity pools that use digital assets — such as stablecoins or wrapped versions of a coin (for example, Wrapped Bitcoin (wBTC)) — may have lesser risks because of their low volatility. In the case of highly volatile assets, however, traders tend to offset their impermanent losses with the yield generated from the liquidity pool. 

Several websites, such as Daily DeFi, have developed online calculators to help traders determine whether depositing their crypto assets into a liquidity pool is worth the risk.

Key Takeaway

Impermanent loss occurs when the value of a token rises or falls after an investor has deposited it in a liquidity pool.

Related Words