Impermanent Loss

Impermanent loss is the loss liquidity providers suffer when they deposit their money in trading pools and one of the staked assets in a pair changes in price. Liquidity pools often tie a stablecoin and a cryptocurrency, which may have a fluctuating price. If the price of the non-stable coin swings, arbitrageurs will take advantage and purchase it at the lower price, impacting the ratio of the staked pair. Withdrawing at a particular moment could cause the liquidity provider to receive less funds than they would have had if they simply HODLed their original deposit.

Despite the possibility of losses, liquidity providers can offset the losses with trading fees. Impermanent losses are like paper losses; they are not realized until the liquidity provider withdraws their assets from the liquidity pools. Liquidity providers will likely experience losses irrespective of the direction of the price swing. Liquidity providers need to choose their automated market makers (AMMs) wisely as some are more vulnerable to impermanent losses than others.