🔍Understanding Impermanent Loss

What is Impermanent Loss (IL)?

Impermanent Loss is a common concept in AMMs (Automated Market Makers) that affects liquidity providers (LPs). It happens when the prices of the tokens you've deposited into a liquidity pool change relative to each other after you’ve added them. This price divergence can cause you to earn less than if you had simply held the tokens in your wallet.

Why Does Impermanent Loss Happen?

In an AMM, you provide two tokens (e.g. USDC and MON) in equal value to a pool. The AMM keeps the ratio of these tokens in balance using a pricing formula like x * y = k (in the case of constant product pools).

When the price of one token increases significantly relative to the other, the AMM automatically rebalances the pool. That means it sells the appreciating asset to maintain the ratio which in turn means that you end up holding more of the underperforming token and less of the outperforming one.

If you withdraw your liquidity after this shift, the total value of your position may be less than if you had just held the original tokens, even after earning trading fees. That difference is the impermanent loss.

Why Is It Called “Impermanent”?

It’s considered “impermanent” because the loss only becomes real when you withdraw your liquidity. If prices return to the original ratio, the loss disappears. However, in volatile markets, that reversal doesn’t always happen.

IL on Monday Trade

Monday Trade supports both AMM-based and orderbook-based liquidity. IL only affects AMM pools, not orderbook market makers. If you're an LP on an AMM pair, it's important to understand this risk and monitor token volatility.

That said, impermanent loss can often be offset by trading fees and incentives, depending on the pair’s activity and reward structure.