Impermanent Loss Meaning

A temporary loss of funds experienced by liquidity providers due to volatility in a trading pair. It occurs because the ratio of the two assets in a liquidity pool must stay balanced according to a specific mathematical formula.

When the price of one asset rises or falls significantly relative to the other, the pool rebalances, leaving the provider with more of the cheaper asset and less of the more expensive one. This loss is "impermanent" because if the prices of the assets return to the same ratio they had when the provider deposited them, the loss disappears.

It only becomes a "permanent" or realized loss if the liquidity provider withdraws their assets while the price ratio is still diverged from the original deposit ratio. For many yield farmers, the goal is to earn enough in trading fees and incentives to outweigh the risk of impermanent loss.

In stablecoin-only pools, the risk of IL is nearly zero because the assets are pegged to the same value, whereas in pools featuring a volatile asset and a stablecoin, the risk is significantly higher.