Providing liquidity can earn a share of trading fees, but it changes what you hold. When the relative price of the pooled assets moves, the pool rebalances your position. The difference between the value of that rebalanced position and the value of simply holding the original assets is commonly called impermanent loss.
Impermanent loss in plain English
Imagine depositing two assets into a pool. Traders buy the asset that rises elsewhere and sell the asset that falls, so the pool ends up holding relatively more of the weaker asset and less of the stronger one. You still own a proportional claim on the pool, but the composition is no longer the one you deposited.
The loss is “impermanent” only in the sense that a return to the original relative price can remove that particular comparison gap before you withdraw. If you withdraw while prices differ, the economic result is realized. Fees can offset the gap, but they do not guarantee a positive result.
Why concentrated liquidity needs extra care
In concentrated-liquidity systems, you choose a price range. A tighter range can make capital more active while the price stays inside it, but it also needs more monitoring. If price leaves the range, the position can become entirely one asset and stop earning fees until it is repositioned. That is a portfolio decision, not passive income.
What to check before adding liquidity
- Know both token contracts and the chain you are using.
- Compare the position with a simple hold scenario at several price moves.
- Read the fee tier, range, and any protocol-specific rules.
- Estimate gas costs for entering, collecting fees, and changing a range.
- Do not count projected fees as certain income.
A small scenario, not a forecast
If one token doubles against the other, the pool typically sells some of the asset that rose and accumulates more of the other. The fee income may be meaningful in a high-volume market, negligible in a quiet one, or outweighed by the price-composition effect. A dashboard’s current APR is a recent observation, not a contract for future return.
Risk is broader than the formula
Impermanent loss is only one risk. A liquidity provider also faces smart-contract risk, token risk, oracle or bridge risk where relevant, and interface or signing mistakes. If you borrow to fund a position, the position also inherits Aave borrowing and liquidation risk.
Sources and further reading
This article is for educational information only and is not personal investment advice.
