🪓Impermanent Loss

What is Impermanent Loss?

What is Impermanent Loss? Impermanent Loss (IL) occurs when the price of tokens you’ve deposited into a liquidity pool changes compared to when you added them. The loss is called “impermanent” because it only becomes permanent if you withdraw your tokens while prices have changed.

How Does Impermanent Loss Happen? Liquidity pools use an automated market maker (AMM) formula, usually keeping the product of token amounts constant (x * y = k). When one token’s price rises or falls, the AMM adjusts the pool by changing the token ratios. This means you end up holding less of the token that increased in value and more of the one that decreased.

Example: Skol’s LP System Suppose you add $500 worth of SKOL and $500 worth of ETH into a 50/50 pool. If ETH doubles in price while SKOL stays the same, the AMM rebalances the pool to keep equal value in both tokens. As a result, you hold less ETH than if you had simply kept it without providing liquidity.

If you withdraw now, you’ll have less total value compared to just holding the tokens (this is impermanent loss). You may still profit overall, but less than if you just HODLed.

Risks in Liquidity Pools Liquidity pairs come with various risks, and impermanent loss is just one of them. Speculative or low market cap tokens paired with more stable assets are especially prone to impermanent loss. However, if your goal is to increase your holdings of the stable or paired asset while participating in the pool, this can still be a beneficial strategy despite the risk.

Pools with less risky, more stable asset pairs usually experience minimal impermanent loss. These pairs tend to have higher trading volumes, which generates more fees that compound over time, increasing your overall returns and helping offset risks.

How Skol Helps Offset Impermanent Loss Skol’s liquidity pools reward providers with trading fees from every swap that occurs in the pool. These fees are shared between token holders and can help reduce the impact of impermanent loss, making liquidity provision more profitable over time.