Calculate IL impact on liquidity positions and determine true LP farming profitability
Impermanent loss (IL) is the difference in value you would have received by holding tokens versus providing liquidity. It occurs when the price ratio of two assets in a liquidity pool changes after you deposit them.
Simple Example:
This loss occurs because the pool rebalances automatically, selling your ETH as its price rises to maintain equal value of both assets. You capture less of the upside than by simply holding.
Where r = (New Price / Original Price)
This formula shows that IL is always negative (a loss). The greater the price divergence (r values far from 1), the larger the IL becomes.
Important: This formula assumes equal deposit amounts. Standard AMM pools (like Uniswap V2) use a constant product formula. The IL formula represents the loss compared to simply holding.
Understanding how IL scales with price changes:
| Price Change | Hold vs LP Return | Impermanent Loss | $100 Initial |
|---|---|---|---|
| 1.1x (10%) | +10% vs +4.99% | -0.45% | $199.55 |
| 1.25x (25%) | +25% vs +19.4% | -2.46% | $219.40 |
| 1.5x (50%) | +50% vs +44.21% | -5.72% | $244.21 |
| 2x (100%) | +100% vs +82.84% | -5.71% | $282.84 |
| 3x (200%) | +200% vs +169.91% | -13.39% | $369.91 |
| 5x (400%) | +400% vs +349.63% | -25.53% | $549.63 |
| 10x (900%) | +900% vs +783.32% | -47.99% | $883.32 |
Notice: IL peaks at around 2-3x price movements, then continues increasing but at a slower rate. This is counterintuitive—extreme moves (100x) still cause significant IL despite the diminishing rate.
Trading fees can offset impermanent loss. A pool with high volume generates significant fees:
Profitability Formula:
Net Return = Trading Fees - Impermanent Loss
Example Scenarios:
Profitable (ETH/USDC High Volume)
Breakeven (Moderate Volume)
Loss (Low Volume + High Volatility)
Uniswap V3 allows you to concentrate liquidity in a narrow price range, increasing capital efficiency and earning more fees per dollar deployed. However, this dramatically increases IL.
Key Insight: Concentrated liquidity is best for stable, range-bound pairs (stablecoins, correlated assets). For volatile assets, keep liquidity spread across wider ranges to avoid being knocked out of range.
USDC/USDT, USDC/DAI pools have minimal volatility and therefore minimal IL. IL might be 0.01% even with active trading. Fees still accumulate steadily on high-volume stablecoin pairs.
Pairs like ETH/stETH or wBTC/renBTC track each other closely and have lower price volatility relative to each other. IL between correlated assets is naturally lower.
Set ranges based on 30-day historical volatility. Example: If volatility is 5%, set a 0.95-1.05 range. Wider ranges = safer but lower capital efficiency. Rebalance regularly.
Farm pools with 1% fees (Uniswap V3) instead of 0.3% to earn more fee income relative to IL. Example: A volatile pair with 30% APY in fees can overcome even 20% IL.
Don't LP shitcoins with 500% daily swings. IL on extreme volatility crushes you. Farm assets with stable, predictable trading volumes.
Use stop-losses on your LP position. If one asset crashes 50%+, IL becomes permanent. Exit early and redeploy in less volatile pairs.
To determine if a pool is worth farming, calculate your breakeven point:
Breakeven Calculation:
Example Decision Tree:
Impermanent loss is the unrealized loss you take when providing liquidity to a pool and the asset price ratio changes. If you held the tokens outside the pool, you would have more value. It is "impermanent" because if prices return to the original ratio, the loss disappears.
Yes and no. It is impermanent if the price ratio returns to where it started. However, if price never returns, your loss becomes permanent. Most IL becomes permanent in practice since assets rarely return to exact previous ratios.
Provide liquidity to stablecoin pools (minimal IL), use correlated asset pairs, farm concentrated liquidity on narrow ranges (Uniswap V3), or choose pair with low historical volatility. Single-sided staking eliminates IL.
Absolutely. If trading fees earned exceed IL, you profit overall. Example: 20% APY in fees minus 5.7% IL = 14.3% net gain. This is why high-volume, low-volatility pairs are ideal for LP farming.
IL = 2*sqrt(r)/(1+r) - 1, where r = new price / old price. For 2x price move: IL = 2*sqrt(2)/(1+2) - 1 = -5.7%. For 5x: IL = -25.5%. Higher price ratios incur proportionally larger IL.
Yes. Concentrated liquidity (narrower price range) increases capital efficiency and fees but dramatically increases IL if prices move outside your range. IL on V3 concentrated positions can exceed 50% on extreme moves.