A Practical Guide to Minimizing Impermanent Loss in AMM Ecosystems

When I first started exploring the world of automated market makers, I felt like a visitor in a new city—curious but a little overwhelmed by all the unfamiliar streets and rules. I remember standing in front of a big, shiny exchange interface, watching numbers flash across the screen, and wondering: “What if I put my tokens into this pool? Will I earn more? Will I lose something I can’t recover?” That mix of excitement and fear sticks with me, and it’s the same feeling you likely have when you look at a liquidity pool for the first time.

The most common anxiety that arises from that initial glance is impermanent loss, a term that, although it sounds technical, is really just a way of saying that the value of your contribution can dip temporarily, depending on how the market moves. In this guide, I’ll walk through what impermanent loss actually is, how it works in practice, and, more importantly, how you can minimize its impact without turning yourself into a statistician or losing the human touch that makes investing meaningful.

Let’s zoom out for a moment. Imagine two people standing in a garden: one brings tomatoes, the other brings basil. If the tomatoes suddenly become cheaper because someone else brings a lot of tomatoes and the basil becomes more valuable, the first person might feel that what they contributed is now worth less compared to not having put it into the garden at all. That’s the core idea behind impermanent loss—your tokens are swapped between two assets, and if their relative prices change, the amount of each that you end up with may differ from what you started with.

What is Impermanent Loss?

In an automated market maker, liquidity providers (LPs) add equal‑value amounts of two assets to a pool. Those assets are combined into a single liquidity pool, where traders swap one for the other. In return for supplying your capital, you earn a fraction of every trade, typically a tiny fee that adds up over time. Impermanent loss occurs when the relative price of those two assets changes after you’ve added them to the pool. Because the AMM automatically rebalances the ratio of the two tokens to maintain a constant product (x × y = k), you’re left with a different distribution of assets than you began with.

Here’s a quick example: suppose you add 50 ETH and 1 000 USDT to a pool. At the time you add them, ETH is priced at 20 USDT, so you’re putting in an equal value of each asset. Later, if ETH climbs to 25 USDT, the pool will now hold fewer ETH relative to USDT to keep the product constant. If you withdraw, you’ll receive more USDT but fewer ETH than you initially deposited. The difference, when compared to simply holding the ETH and USDT outside the pool, is the impermanent loss.

If the pool’s fee structure is generous and trades are frequent, that fee can offset a large portion of the loss over time—sometimes more than 1% of your deposited capital per month. But if the pool sees low volume or your assets experience large price swings, the loss can be significant. That’s why it’s vital to understand the dynamics that drive impermanent loss and how to structure your participation to stay on the healthier side of the ledger.

Common Emotions Behind Impermanent Loss Discussions

When people talk about impermanent loss, it isn’t just a math problem; it’s a psychological one. Fear often dominates, because the word “loss” has a heavy emotional weight. Then there’s greed—they want a quick, high return from the pool’s fee revenue and wonder when it actually overtakes potential loss. Finally, hope and uncertainty swirl. People hope that the fee income will keep coming, but uncertainty about future price moves keeps them on edge.

That feeling resonates because we’re all investors who have ever wondered if a particular strategy is worth the risk. In my own journey from portfolio manager to independent educator, I’ve seen both sides: someone who was thrilled by the first fee earned and later regretful after a market shock—plus many who never felt the pain because their risk appetite and strategy kept them safe. The key is to blend clarity and empathy: you can share the math but never forget the human story behind it.

How Does Impermanent Loss Work Under the Hood?

Below is a simplified walk-through that shows the math:

Deposit:    | 50 ETH   | 1 000 USDT
Initial price: ETH/USDT = 20
Pool value:   1 000 USDT of each
Constant product: k = 50 ETH × 1 000 USDT = 50,000

When ETH rises to 25 USDT:

The product k stays 50,000.
If the pool holds (y) USDT, it will hold (x) ETH such that (x \times y = 50,000).
Solve for (x = 50,000 / y).

If the pool’s new composition is (y = 800) USDT, then (x = 62.5) ETH. Notice that the pool now holds 62.5 ETH—more than the 50 ETH you originally added, but the USDT fell to 800 from 1 000. When you go to withdraw, you’ll get 62.5 ETH and 800 USDT. Comparing that to 50 ETH and 1 000 USDT you had before, the loss materialises as a shortfall in total value (assuming the market price of ETH is 25 USDT, your withdrawal would be worth 1 562.5 USDT, whereas your initial deposit would have been 1 500 USDT of pure holdings). That extra 62.5 ETH appears to be a gain, but the loss in USDT actually tilts the balance. In practice, the fee income and the pool’s rebalancing often offset, but that’s where the real math lives.

Why Impermanent Loss “Mits” in a Certain Ways

The loss is “impermanent” because if the relative price of the assets returns to the level they were at when you entered the pool, the fee income will have fully compensated for the loss. Think of a tide: a little higher tide rises and then settles back down. Over the long haul, the pool might recover you to the starting point. But if you exit while the tide is still high or low, you capture the loss.

Another factor is the depth of the pool—how much liquidity it holds. In a deep pool, price movements have a comparatively smaller impact on the ratio of assets, thereby reducing impermanent loss. In shallow pools, even a modest price shift can dramatically alter your asset allocation. This is why a quick look at the pool’s total value locked (TVL) can be revealing: the higher the TVL, the steadier the environment tends to be.

Real-World Scenarios

Let’s paint a picture with a real pair: Uniswap v3 ETH/USDC pool. A trader who added 1 ETH and 20 USDC when the price was 20 USDC/ETH entered a fairly stable environment. The fees collected over several months yielded a 0.3% daily return on the total pool value. Meanwhile, the price of ETH drifted from 20 to 22 USDC—a 10% increase. In that case, the pool rebalanced, giving the trader around 1.05 ETH and 19 USDC on withdrawal. Translating back to a nominal value, the trader ended up with a combined value close to the original deposit, plus the fee revenue.

Contrast that with a pair like FRAX/DAI. Although both are stablecoins, they can diverge slightly because of protocol adjustments, liquidity incentives, or market forces. Suppose you add 50 FRAX and 50 DAI. Each is supposed to be 1:1, but if their rates drift to 0.97 DAI for every 1 FRAX, the pool will hold more FRAX and less DAI, causing a small impermanent loss relative to simply holding 50 FRAX and 50 DAI. Because the drift is minimal, that loss may be negligible—but if the divergence widens, the loss will be larger, even though the assets themselves remain stablecoins.

A Story from a Friend

My friend João from Porto had a curiosity about liquidity mining. He joined a new AMM and deposited 10 BTC and 50 USDT at the beginning of a whale crash. The BTC then dropped 30% over a month. João stayed in the pool and eventually withdrew. The fees he collected were modest, but the pool’s rebalancing gave him a slight underweight in BTC and weight in USDT. When he compared his final holdings to a simple “cash hold” (just holding BTC and USDT in his wallet), he realized that he had lost a slice of opportunity that could have been used to buy cheaper BTC later. That’s a classic case where the high volatility of an underlying asset amplified impermanent loss.

Practical Ways to Minimize Impermanent Loss

You might think that impermanent loss is a fixed, unavoidable cost. In reality, it’s very much a strategic decision that you can influence. Below are some practical ways to manage, reduce, or even use impermanent loss to your benefit, all while keeping the process understandable and human.

1. Pick the Right Pair

Stable pairs: If you’re uneasy about volatility, look for pairs of assets that stay close in value: stablecoins, or pairs that follow the same trend (e.g., BTC/USDC). Because price divergence is small, the rebalancing never dramatically skews your holdings.

Higher fees, lower volatility: Some pools charge higher fees (for example, v3's concentrated liquidity). If the fee rate compensates for the potential loss, it can tilt the equation in your favor. Always calculate the breakeven fee rate first: if you’re in a pair where the volatility is low, a modest fee can offset most loss.

2. Add Liquidity When Prices Are Near-Equal

Impermanent loss is greatest when you add liquidity at a time when the two assets have a high price difference. If you add when their value ratio matches the pool’s target ratio—meaning the pool’s “price curve” meets the external spot price—you’re already in a favourable position. Monitoring external price indices or using price oracles can help you spot that sweet spot.

3. Use Time Windows Strategically

Liquidity provision is not a “set and forget” operation. Because impermanent loss is partly a function of price divergence over time, you can think of it as a risk that compounds the longer you stay in the pool. A useful tactic is to:

Short‑term staking: Keep funds for a few days or weeks, especially if the pair is low volatility. In that duration, you collect fees faster than you accumulate loss.
Long‑term exposure: Some protocols allow you to hold liquidity in “locked” positions for longer, but evaluate if the projected fee income outweighs the volatility risk over the lock period.

4. Monitor TVL and Pool Depth

Deep pools are like big lakes: a drop of water (price change) won’t raise the water level too drastically. Checking the pool’s TVL (total value locked) gives you a sense of liquidity depth. A lower TVL indicates a shallower market that’s more sensitive to trades, and thus more susceptible to impermanent loss. If you’re working with a high‑volatility token pair and a shallow pool, you may want to either add less or exit earlier.

5. Combine Impermanent Loss with Yield Farming

Many protocols bundle liquidity provision with other yield-generating opportunities. You might lock your LP tokens into a farming pool that grants you additional tokens. Those extra tokens can offset or even outweigh any impermanent loss, especially if the farming rate is high. But be careful: the farming reward often comes with its own risk (token price fluctuation) and sometimes lock periods that could expose you to a sudden drop in your farmed tokens.

6. Diversify Across Pairs

Instead of putting all your money into one pool, spread it across several low‑correlation pairs. Even if one pair incurs a substantial impermanent loss, the whole portfolio might remain balanced. Diversification can be particularly useful if you’re concerned about a single pair’s price swing.

7. Use Impermanent‑Loss‑Protection Protocols (if available)

A newer wave of DeFi protocols offers “impermanent loss insurance” or “buffers,” where you could lock a portion of fees to cover potential losses. These usually come at a small cost (you give some of your fee income to the insurance). In some protocols, the cost is a fraction of the potential loss, making it worthwhile in high‑volatility situations.

8. Exit Strategically

If you see your relative asset weights diverging heavily, you may consider a partial exit. For example, if the pool now holds 60 % USDC and 40 % ETH, but your original investment was 50/50, you could remove a small portion of your liquidity to bring the wallet’s exposure back in line. That way, you capture some of the fees without fully surrendering to the new imbalance.

The Take‑Aways from a Human Perspective

I’m not telling you that you have to become a math wizard to avoid impermanent loss—or that there’s a single “magic” strategy that works for every situation. It’s about being aware of the tool you’re using and matching it to your own risk tolerance, time horizon, and appetite for complexity.

Know your own threshold: How much are you willing to potentially lose for the chance of earning a few percent per month? Set a cap and stick to it.
Monitor, but don’t obsess: Check your positions a few times a week. Not daily; that turns it into a form of obsessive monitoring that can lead to panic or panic buying.
Combine it with other educational resources: If you’re new to liquidity farming, start with a single, low‑volatility pool while you learn: maybe USDC/USDT or a stablecoin pair. Let the experience build your confidence before branching into more volatile pairs.

Remember, impermanent loss is less about a moral failing or a mistake and more about the dynamic relationship between your capital and market forces. The term “impermanent” is key; it suggests that this is a temporary state that can be resolved by either continuing to accrue fee income or by exiting at an opportune moment. It’s a reminder that markets cycle and that sometimes your investment moves in the opposite direction—then later they might come back. It means that patience and discipline can pay off even if you’re in a temporary misbalance.

A Calmer Way Out of the Fog

When the feeling of loss creeps up, I encourage you to step back and look at the broader picture: look at your overall portfolio, your longer‑term goals, and how much you’re able to let a part of your capital sit in a pool. Think of the pool not as a hazard but as another component of a well‑structured ecosystem. If your portfolio is analogous to an investment garden, the AMM pools are like compost bins: they take waste, recycle it, and sometimes lose a bit of the original material, but in the long term, the compost enriches the soil, helping your other investments grow.

Finally, the best practice is to keep a written note of why you chose a particular pool, at what price you entered, and what your expectations were. Treat it like a brief diary entry. When you look back, you’ll see that your decision was not a blind bet but a considered action against a backdrop of risk, reward, and human judgment.

As I always say, it’s less about timing, more about time. Markets test patience before rewarding it. By aligning your strategy with that patience, you can keep the impermanent loss narrative a part of the learning curve rather than let it dominate your emotional experience.

At the end of the day, the most valuable takeaway is this: impermanent loss is a predictable, calculable effect; the way to minimize it is to blend data, strategy, and emotional awareness. Choose the pairs that suit your risk appetite, stay in well-liquid pools, and don't let the fear of impermanent loss freeze your ability to make consistent, small gains. If you’re careful, the fee revenue can not only offset the loss but become a steady paycheck for your portfolio. That, in turn, makes your financial journey smoother, more reliable, and far less stressful.

And if at any point you feel uncertain, remember that acknowledging uncertainty is the first step toward better decision‑making.

Let’s finish by taking that first small step—pick a pair, check its recent fee history, watch its TVL, and then add a small amount of capital you’re comfortable with. Use it as a learning experiment. Over time, you’ll see that the fear of impermanent loss is one aspect of a larger, much richer strategy, and you’ll be able to trade in these pools with more confidence and less anxiety.

Feel free to pause, reflect, and then move forward steadily. Your capital will thank you for the steady, measured approach you’ve chosen.