What is Impermanent Loss in DeFi?
Impermanent loss is a phenomenon in decentralized finance (DeFi) that occurs when providing liquidity to automated market makers (AMMs) or liquidity pools. When users deposit their cryptocurrency into a liquidity pool, they typically receive a proportional amount of pool tokens in return. These tokens represent their share in the pool and give them a claim to a portion of the fees generated by the platform.
However, the value of the assets in the pool can fluctuate over time due to market conditions. If the price of the deposited assets changes significantly after a user has contributed to the pool, the value of their total holdings may be less than if they had simply held the assets in their wallet. This difference in value is referred to as impermanent loss.
The term "impermanent" is used because the loss can be mitigated or reversed if the price of the assets returns to their original levels. Additionally, liquidity providers earn fees from trades occurring in the pool, which can offset some of the impermanent loss. However, it is essential for potential liquidity providers to understand and assess the risks associated with impermanent loss before committing their funds to a DeFi project.