Definition
The temporary loss of value experienced by liquidity providers when the price of tokens in a pool changes relative to when they were deposited. If prices diverge significantly, LPs may have less value than if they had simply held the tokens.
Why It Matters
Impermanent loss is the hidden risk of providing liquidity in DeFi. Understanding it is essential before depositing into any AMM liquidity pool.
Example
You deposit ETH and USDC into a Uniswap pool when ETH = $2,000. ETH rises to $4,000. The AMM automatically rebalanced the pool by selling your ETH, leaving you with less ETH than you started with.
Related Terms
Liquidity Pool
AMM
DeFi
Yield Farming