Risk of Impermanent Loss (IL)

Impermanent loss, also called divergence loss, is the most common liquidity provider risk associated with traditional (constant product) liquidity pools. It occurs when the relative price of the tokens in the pool changes and the value of the LP’s initial token deposit in the pool becomes less compared to holding the tokens separately without depositing them in a pool. LPs must learn to manage IL.

Consider a scenario where you LP into an A/B pool and the value of token A increases against token B; you will end up with more of token B and less of A. If the combined value of your eventual A and B token amounts in the pool is now less than if you had simply held the original tokens (without providing liquidity), you’d have suffered IL. This loss is “impermanent” because it is only fully realized when you withdraw your liquidity. Since IL increases as price diverges, it is exacerbated by higher market volatility.

Below are two simple examples.

Example 1:

You deposit $100 of BONK and $100 of SOL into a traditional constant product liquidity pool. The price of BONK does a 1.5x, reaching 150% of its original value while the price of SOL remains the same.

If you had not deposited in the pool, you would now have $150 of BONK and $100 of SOL for $250 total.

Since you deposited in the pool, if the total combined value is now $245, the $5 difference from $250 represents your impermanent loss.

Example 2:

You deposit $100 of BONK and $100 of SOL. The price of BONK does a 4x to 400% its original value while the price of SOL remains the same.

If you had not deposited in the pool, you would now have $400 of BONK and $100 of SOL, totaling $500.

Since you deposited in the pool, you would instead have $200 of BONK and $200 of SOL, totaling $400, for a $100 impermanent loss. The greater the divergence in price between the two assets, the greater the impermanent loss. If the relative prices return to the original ratio, the loss will be recovered, which is why it is called impermanent. However, it is permanent if the price ratio does not recover.

Note that these examples do not include any fees taken by the pool during that period, or any yield from a farm, lending protocol or other source. If income from those other sources outweighs impermanent loss, it is still a net gain overall.

How do I calculate my impermanent loss on DLMM?

There is a precise formula to calculate the impermanent loss for a given start and end point based on the relative price changes between the assets in the pool.

We created a simple google sheet as a helpful tool to manage your IL on the DLMM. It is currently set up for checking a position with 69 bins and an equal distribution of liquidity across the bins. Your actual liquidity distribution may be very different and would change the IL calculation here. Additionally, your 24hr fee / TVL for your position may also be different.