What is Impermanent Loss (IL)
Impermanent loss is a temporary reduction in value experienced by liquidity providers (LPs) in decentralized finance (DeFi) pools when the price of deposited assets changes relative to each other compared to when they were deposited. It represents the opportunity cost of providing liquidity instead of simply holding the assets in a wallet, as automated market makers (AMMs) constantly rebalance token ratios to maintain liquidity.
The loss is termed "impermanent" because it is only realized if the LP withdraws their funds while prices remain divergent; if token prices revert to their original ratio, the loss disappears entirely. The magnitude of impermanent loss increases with higher market volatility and greater price divergence, meaning LPs may end up with less total value than they would have had by just holding the tokens, unless trading fees earned offset this deficit.