What is impermanent loss?
Impermanent loss is the difference between the value of assets supplied to a liquidity strategy and the value those assets would have had if they had been held separately. It happens when the relative price of the assets changes while liquidity is active. The difference is called “impermanent” because it can shrink or disappear if prices return to their original relationship before the liquidity is withdrawn. If you withdraw while the difference remains, it becomes a realized loss compared with holding the assets.
How does impermanent loss happen?
When a trading strategy updates its prices or balances as the market moves, trades can change the mix of assets held for that strategy. For example, if Token A rises sharply relative to Token B, the strategy may end up with less Token A and more Token B. The value of the assets you withdraw may be lower than the value you would have had by holding the original amounts outside the strategy.
The exact outcome depends on the strategy’s pricing model, the size and direction of the price change, the assets involved, fees, and any incentives. Impermanent loss is a comparison against holding; it does not necessarily mean that the dollar value of your position has fallen.
How Aqua and SwapVM fit in
Aqua is 1inch’s shared liquidity layer. It lets liquidity providers allocate balances across multiple trading strategies while keeping their tokens in their own wallets; Aqua tracks virtual balances and settles swaps when a strategy executes.
SwapVM is a computation engine that executes token-swap strategies from bytecode programs. A strategy can use different pricing, balance, fee, and execution rules. When a SwapVM strategy uses Aqua-managed liquidity, Aqua provides the shared liquidity layer and SwapVM executes the strategy’s swap logic.
Aqua and SwapVM do not remove market risk or guarantee liquidity earnings. They also do not mean that every strategy has the same risk profile. Whether impermanent loss applies, and how large it may be, depends on the specific application and strategy used with the liquidity.
Simple example
Suppose you provide equal values of Token A and Token B to a strategy. Token A then increases substantially in price relative to Token B. Trading activity may leave the strategy with a smaller amount of Token A and a larger amount of Token B. When you withdraw, compare the value of those assets with the value of the original Token A and Token B amounts held separately. The difference between the two results is the impermanent loss.
Fees and incentives
Trading fees or other incentives can offset impermanent loss, but they are not guaranteed and may vary by application or strategy. Review how fees and incentives are calculated before providing liquidity.
Before supplying liquidity, check:
Which application and strategy will use the liquidity
How the strategy calculates prices and balances
Which fees and incentives apply
How and when liquidity can be withdrawn
The smart-contract and token-volatility risks involved