If you are trying to earn passively through cryptocurrency, this term is one you should be aware of. The concept of Impermanent loss is found in decentralized finance. It is a term used to explain the loss you incur when you put your tokens in a DeFi pool rather than hold them in your wallets.
For example, imagine you enter an ETH/LINK pool (Chainlink will launch staking this year. You can see more about their updates in the Chainlink price prediction 2025).
And at the time you decide to withdraw, the value of your investment in Dollars is less than the amount it would be worth if you did not borrow your tokens to a pool.
This loss is called impermanent (no need to be confused. It is also called temporary) because you have not withdrawn your tokens from the pool.
Like the temporary loss, there are several other risks involved in putting your tokens in a token pool. The major ones are liquidation risk and control risk.
There are also quite a number of factors that influence temporary losses. One of these is the number of token providers present in the pool, and another is the type of token that is in the pool. Stablecoins have been proven to be less susceptible to temporary loss. While more often than not, that pools with cryptocurrency suffer from a temporary loss.
Interestingly, people keep putting tokens in token pools because the trading fees earned usually compensate for the losses. So if there is a temporary loss, the fees make it a zero-sum game, and if there is no temporary loss, the fees make token provision more profitable.
How Does It Work?
Can token provision be insured? Yes. Providers can be saved from sudden losses through a concept known as temporary loss protection. The importance of this insurance is that it serves as a form of a hedge when token providers suffer losses in the pools.
A good example of this is the Bancor protocol. When you deposit tokens in the Bancor pool, your insurance grows by 1% daily when the stake is active. Normally, after 100 days, you should have 100%. The insurance will pay for any temporary loss that occurs during this period.
If any withdrawal is made before the 100 days is over, you will get the percentage compensation according to the number of days you were in the pool. This does not work when you withdraw any money between the first 30 days. You earn no compensation.
Let’s See a Hypothetical Scenario
James is a token provider. He has 10 ETH and would love to provide token in an ETH/USDC pair. If 1ETH equals 100 USDC, James would need to have 1000 USDC in the pool too.
Supposed the pool has an asset value of 10,000 USDC (5000 USDC and 5 ETH), then James’ share of the pool will be 20%
If the pool they commit to has a total asset value of 100,000 USDT (50 ETH and 50,000 USDT), their share will be equivalent to 20% using this simple equation = (20,000 USDT/ 100,000 USDT)*100 = 20%. Compared to another user, Janet, who has 5% of the pool, James’ risk of temporary loss is higher.
How Can it be Avoided?
There is no way for token providers to avoid temporary losses. However, they can use some measures in order to modify their risk, such as using stablecoin pairs and avoiding volatile ones at all costs.
When it comes to avoiding temporary losses, one strategy is choosing stablecoin pairs so you can minimize your risks.
The value of these coins doesn’t move too much, and they have fewer arbitrage opportunities which reduces risk even more! Stablecoins also help token providers because their prices don’t change based on what’s happening in other markets like cryptocurrencies or fiat currencies.
Always make sure to choose pairs that do not expose your token and funds in case of market instability or temporary loss. Another strategy would be searching through the highly volatile crypto space, which can lead you towards some good finds.
In order to maintain stability in the market, token providers must know when it is time for them to sell their assets before prices change too far from starting rates.
The current state of DeFi is a major problem for financial institutions, which are afraid that they might lose money if users leave their token pools. This leads many banks to avoid participating in these types of products altogether- but it can easily be fixed with help from AMMs.
Conclusion
Like every other transaction that happens on the blockchain, yield farming activities are recorded on the blockchain. If the tokens are Ethereum-based, they would be recorded on the ether block explorer. The knowledge of temporary loss helps token providers understand the risk of yield farming.
