🔻Risk of Impermanent Loss

Impermanent loss is the negative difference between the value of a user's tokens deposited in a liquidity pool and the value of the tokens if the user had just simply held them.

When the price of the asset you deposited into a liquidity pool changes, an arbitrage opportunity is created because of the price difference between our liquidity pool and other exchanges. As tokens are added and removed from the liquidity pool during arbitrage, the value of your share of tokens will decrease, leading to a loss in the value of your position. In some cases, an investor would have been better off just holding a token, avoiding the IL and forfeiting the yield.

It is worth noting these losses are only permanent if your funds are withdrawn. Losses may be mitigated If the asset's market value returns to its original price. In many cases, the impermanent loss is reduced or prevented via the trading fees earned in a liquidity pool.

Impermanent loss is a unique byproduct of how automated market maker (AMM) systems work. To maintain an asset's price and to enable trading without a traditional order book, trading pairs must maintain asset pools at a certain fixed ratio. When trades occur, tokens are simultaneously deposited and removed from the pool while maintaining the original ratio value. This core mechanism is the reason why impermanent loss can occur.