Liquidity pools
You collect trading fees, and you pay a cost that only appears when prices move. Both are real, and only one gets advertised.
Trading on a decentralised exchange does not match buyers with sellers. It trades against a pool of assets that somebody deposited, and that somebody collects a share of the fees.
Supplying such a pool is called providing liquidity. It pays real money, and it carries a cost that is mechanical rather than accidental — which is why it deserves a page rather than a footnote.
How a pool works
A pool holds two assets and a rule connecting them. The rule sets the price: as traders take one asset out, they must put more of the other in, and the price moves along a curve.
You deposit both sides in the ratio the pool requires. Every trade pays a fee, typically a fraction of a per cent, split among depositors. Busy pool, more fees.
That is the whole earning mechanism, and it is honest: traders pay for a service, you supplied the inventory.
The cost with the misleading name
Impermanent loss is what happens to your position when the two assets change in price relative to each other. It is not a fee, nobody takes it, and it is not a bug.
The pool always rebalances toward whichever asset is falling. If one asset doubles, the pool has been selling it into the rise the whole way up, and you end up holding less of the winner and more of the loser than if you had simply kept both.
It is measured against holding, not against zero
You can end a period with more money than you started and still have suffered impermanent loss — because simply holding the two assets would have left you with more. That is the comparison that matters, and it is not the one the interface shows you.
The word "impermanent" refers to the fact that if prices return to where they started, the gap closes. They frequently do not, and the moment you withdraw it stops being impermanent and becomes the result.
What supplying a pool costs when the price moves
A two-sided pool sells whatever is going up, the whole way up. That keeps the sides balanced and leaves you with less of the winner than if you had done nothing.
It is called impermanent because it closes if the price comes back. Withdraw while it has not, and you have simply paid it. The figure ignores the fees you earn, which is the other half — and the only half that gets advertised.
Roughly how big
The effect is mild for small moves and grows quickly with large ones. A 25 per cent divergence between the two assets costs a fraction of a per cent. A doubling costs around five per cent. A fivefold move costs around a quarter of the position, measured against having held.
Which explains the shape of the whole business: fees have to outrun divergence, and divergence is what happens in the markets people find exciting.
When it works and when it does not
- Two assets that track each otherTwo dollar stablecoins, or a staked token against the asset it represents. Divergence is small by construction, so fees dominate. The most defensible version of this.
- Two large assets in a busy poolReal fees, real divergence. It can work over long periods and the outcome depends on how much trading happens versus how far prices move.
- A new token against a major assetHeadline rates are enormous and so is divergence. If the token falls hard, you hold nearly all of it and nearly none of what you paired it with.
Risks that are not impermanent loss
Contract flaws. Your deposit sits in software. This is the risk that has produced the largest single losses.
One-sided pools. If the token you paired collapses to nothing, the pool ends up holding almost entirely that token. Impermanent loss becomes total loss, and no fee rate compensates for it.
Exit design. Some pools charge to withdraw or require a wait. Read that before depositing rather than after.
A four-figure percentage on a new pool is a warning, not an opportunity
Rates like that exist because the project is spending its own token to rent liquidity, and because almost nobody is willing to hold the other side. Both facts point the same way.
Before you supply anything
Work out what the fees have earned over a period you can verify, not what the projection says. Look at how far the two assets have diverged in that same period. If the second number is larger than the first, the pool has been paying its depositors to lose money, and the interface will not say so.