Impermanent loss

Impermanent loss is a phenomenon that occurs in liquidity provision or liquidity mining on decentralized exchanges (DEXs) that use an automated market maker (AMM) pricing mechanism. It is the opportunity cost or loss incurred by providing liquidity in a trading pair due to price volatility. When a liquidity provider (LP) adds tokens to a pool, they receive liquidity provider (LP) tokens in exchange, which represents their share of the pool. The LP tokens can be redeemed for their proportional share of the liquidity pool's value, which consists of the tokens provided by the LP and any trading fees earned by the pool. However, as the price of the trading pair fluctuates, the value of the LP's share in the pool changes. Due to the price volatility, impermanent loss occurs when the value of one token in the pool increases or decreases compared to the other token, causing the LP's share to be imbalanced. When the LP withdraws their liquidity, they may receive fewer tokens than they originally deposited or more tokens, resulting in impermanent loss. Impermanent loss is called "impermanent" because it disappears over time if the prices of both tokens return to their original value. If the LP stays in the liquidity pool for the long term, impermanent loss can become permanent loss if the price difference between the two tokens persists and the LP decides to withdraw their liquidity at a time when the prices have diverged.