DIGITAL ASSETS
Impermanent Loss (DeFi) Singapore
The hidden cost of supplying liquidity to a trading pool
Last updated: September 2026
Impermanent loss is the reduction in value experienced by someone who supplies two tokens to a decentralised exchange’s liquidity pool, compared to simply holding those same tokens, which occurs whenever the price ratio between the two tokens changes after the deposit is made.
Not financial advice. All figures for educational reference only. Data as at September 2026.
Key Takeaways
- Impermanent loss happens because automated market maker pools automatically rebalance the two tokens as prices move, leaving the liquidity provider with more of the token that fell in relative value and less of the one that rose.
- The loss is called impermanent because it only becomes permanent, or realised, when the liquidity provider withdraws from the pool; if the price ratio returns to where it started, the loss disappears.
- The larger the price divergence between the two pooled tokens, the larger the impermanent loss, growing disproportionately as the gap widens.
- Trading fees earned from the pool can offset or even exceed impermanent loss over time, especially in high-volume pools with relatively stable, correlated token pairs.
- Pools made up of two highly correlated assets, such as two stablecoins, experience far less impermanent loss than pools pairing a stablecoin with a volatile asset.
Table of Contents
What Is It?
How It Works in Singapore
Example
Advantages
Risks and Limitations
Providing Liquidity vs Simply Holding the Same Tokens
The Bottom Line
FAQ
What Is Impermanent Loss?
Automated market makers, or AMMs, are the mechanism underlying most decentralised exchanges in DeFi. Instead of matching individual buy and sell orders the way a traditional exchange does, an AMM uses a liquidity pool and a pricing formula, commonly a constant-product formula, to let anyone trade against the pool at an algorithmically determined price.
A liquidity provider is someone who deposits an equal value of two tokens, for example ETH and a stablecoin, into such a pool. In return, they receive LP tokens representing their proportional share of the pool, and they earn a cut of the trading fees generated whenever someone trades against that pool.
Impermanent loss arises because, as traders buy and sell against the pool, the AMM automatically adjusts the ratio of the two tokens it holds to maintain its pricing formula. This means the liquidity provider’s share ends up holding relatively more of whichever token depreciated and less of whichever token appreciated, compared to what they would have if they had simply held both tokens separately outside the pool.
How Does It Work in Singapore?
The mechanism follows directly from how a constant-product AMM maintains its pricing formula. When one token’s external market price rises, arbitrage traders buy that token from the pool, since it is temporarily underpriced relative to the wider market, until the pool’s internal ratio realigns with the market price. The practical effect is that the pool ends up holding less of the appreciating token and more of the depreciating or flat one.
As a rough rule of thumb, at a 2x price divergence between the two pooled tokens, impermanent loss works out to roughly 5.7% of the pool’s value compared to simply holding the tokens; at a 4x divergence, it rises to roughly 20%. The loss grows faster than the price divergence itself, which is a key reason sophisticated liquidity providers pay close attention to how volatile and correlated a token pair is before depositing.
The offsetting factor is trading fee income. Fees earned proportionally to the liquidity provided accrue continuously and can offset some or all of the impermanent loss, particularly in high-volume, popular pools. This is why experienced liquidity providers typically evaluate a pool based on its expected fee income relative to its expected price divergence, rather than looking at impermanent loss in isolation.
Some newer DeFi protocols have introduced concentrated liquidity models, which let a liquidity provider specify a narrower price range within which their capital is active, potentially earning a larger share of fees for the same capital. This comes at the cost of a steeper impermanent loss profile if the price moves outside that chosen range entirely, since their liquidity effectively stops earning fees once the price exits the range altogether.
Impermanent Loss Example
An investor deposits S$5,000 worth of ETH and S$5,000 worth of a stablecoin, S$10,000 in total, into a liquidity pool. If ETH’s price then doubles relative to the stablecoin, arbitrage trading against the pool leaves the investor’s share worth roughly S$9,660 at withdrawal time, versus the roughly S$11,180 they would have if they had simply held the original ETH and stablecoin separately without depositing into the pool at all. That approximately S$1,520 shortfall is the impermanent loss, though in practice trading fees earned during that period would partially offset it, and the loss remains unrealised, or ‘impermanent’, unless the investor actually withdraws while the price ratio remains diverged.
Advantages of Impermanent Loss
- Liquidity providers earn a share of trading fees generated by the pool, which can be an attractive yield source, particularly in high-volume pools.
- Providing liquidity to a stablecoin-to-stablecoin pool exposes the provider to minimal impermanent loss, since the two assets rarely diverge meaningfully in price from each other.
- Because the loss is unrealised until withdrawal, a liquidity provider who expects the price ratio to eventually revert can simply wait it out rather than crystallising the loss.
- Understanding impermanent loss lets an investor choose pools and token pairs more deliberately, favouring correlated assets or high-fee pools where the trade-off is more favourable.
Risks and Limitations
- Impermanent loss can become a very real, permanent loss the moment a liquidity provider withdraws while the two tokens’ prices remain diverged.
- The loss grows disproportionately with the size of the price divergence, so pools involving one highly volatile token can carry meaningfully more risk than they might first appear to.
- Trading fee income is not guaranteed to offset impermanent loss; in low-volume pools, or during periods of sharp, one-directional price moves, fees can fall well short of covering the loss.
- Impermanent loss is a distinct risk from smart contract risk or stablecoin de-pegging risk in DeFi lending; a liquidity provider is exposed to all of these simultaneously, not just one at a time.
Providing Liquidity vs Simply Holding the Same Tokens
How a liquidity position performs relative to simply holding the underlying tokens depends heavily on how their prices move.
| Price Scenario | Liquidity Pool Outcome | Just Holding the Tokens |
|---|---|---|
| Both tokens’ prices stay roughly the same | Value roughly matches holding, plus trading fees earned | Value stays roughly the same, with no fee income |
| One token doubles in price relative to the other | Value is lower than holding by roughly 5.7%, before fees | Full benefit of the price increase is captured |
| One token falls to a quarter of its relative price | Value is lower than holding by roughly 20%, before fees | Full downside of the price decrease is felt, but no additional loss beyond that |
Source: Standard AMM constant-product formula impermanent loss calculations, widely used across DeFi protocol documentation.
The Bottom Line
Impermanent loss is the price liquidity providers implicitly pay for earning trading fees in a DeFi pool. It rewards pools of correlated, low-volatility assets and high trading volume, and punishes liquidity provided to a pair where one token’s price moves sharply against the other.
Frequently Asked Questions
Why is it called impermanent loss if it can become permanent?
Can trading fees fully offset impermanent loss?
Do stablecoin-to-stablecoin pools have impermanent loss?
How is impermanent loss different from simply losing money when a token's price falls?
Is impermanent loss the biggest risk in DeFi liquidity provision?
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