We propose a continuous-time stochastic model to analyze the dynamics of impermanent loss in liquidity pools in decentralized finance (DeFi) protocols. We replicate the impermanent loss using option portfolios for the individual tokens. We estimate the risk-neutral joint distribution of the tokens by minimizing the Hansen–Jagannathan bound, which we then use for the valuation of options on relative prices and for the calculation of implied correlations. In our analyses, we investigate implied volatilities and implied correlations as possible drivers of the impermanent loss and show that they explain the cross-sectional returns of liquidity pools. We test our hypothesis on options data from a major centralized derivative exchange.