Inventory Risk Meaning

The risk faced by a market maker or a dealer that the value of the assets they are "holding on their books" will drop before they can sell them to a buyer. To provide a smooth market, market makers must always be ready to buy when someone wants to sell, meaning they always have some "inventory." If the market is highly volatile, the market maker might buy an asset for $100 and find that by the time they find a buyer 10 minutes later, the price has dropped to $95.

This loss is the realization of inventory risk. To protect themselves, they often charge a wider "bid-ask spread" in volatile markets.

Automated Market Makers (AMMs) handle inventory risk differently.

They don't have a "dealer" in the middle; instead, the risk is borne by the liquidity providers through "impermanent loss." In both cases, inventory risk is the "cost" of providing liquidity to others, and it must be managed carefully to ensure the market remains functional.