When providing liquidity for an AMM in decentralized finance (DeFi), investors must deal with the possibility of permanent loss. Although it is not an actual loss incurred from the liquidity provider’s (LP) position — rather an opportunity cost that occurs when compared with simply buying and holding the same assets — the possibility of getting less value back at withdrawal is enough to keep many investors away from DeFi.

Impermanent loss is driven by the volatility between the two assets in the equal-ratio pool — the more one asset moves up or down relative to the other asset, the more impermanent loss is incurred. A simple way to decrease impermanent risk is to provide liquidity to stablecoins and avoid volatile asset pair pairs. These strategies may not offer as appealing yields.

Impermanent losses can be reduced by having uneven liquidity pools

Multi-asset liquidity pool are an important step in the right direction

One-sided liquidity pool are best

Automated LP manager can reduce investors’ headaches