Beyond Break Even: Understanding Crypto Liquidity Pools

If you only trade on centralized exchanges (CEXs) like Binance or Coinbase, our Break Even Calculator will perfectly map out your precise profitability requirements. You pay an open and close fee. Math complete.

However, if you venture into Decentralized Finance (DeFi) to earn yields, the math changes drastically.

What is a Liquidity Pool?

Decentralized Exchanges (DEXs) like Uniswap don't have order books connecting buyers and sellers like traditional stock markets. Instead, they use Liquidity Pools—massive smart contracts containing millions of dollars of two tokens (e.g., ETH and USDC).

Users ("Liquidity Providers" or LPs) deposit their tokens into these pools to facilitate trading for others, and in return, they earn a cut of the trading fees swapped across the network.

The Catch: Impermanent Loss (IL)

While earning passive trading fees sounds great, providing liquidity to a pool consisting of a highly volatile asset (ETH) and a stable asset (USDC) exposes you to the infamous Impermanent Loss (IL).

IL happens when the relative price of your deposited assets changes compared to when you deposited them. The automated market maker (AMM) algorithm will constantly rebalance your portfolio as prices shift using the formula x * y = k. This means if ETH skyrockets in price, the pool sells your ETH to buy USDC to maintain balance. You will end up with less ETH and more USDC than you started with.

If you withdraw your liquidity at that moment, you would have been better off simply holding the raw ETH in your wallet rather than providing liquidity. That missed profit is the "impermanent" loss (it becomes permanent the exact second you click withdraw).

Using Calculators to Hedge

When evaluating complex DeFi strategies, you must calculate whether the fees and Compound Interest you earn will mathematically outweigh the potential Impermanent Loss over a specific time horizon. Ensure your yield is vastly superior to a simple buy-and-hold strategy before locking capital in smart contracts.