Impermanent Loss

Impermanent loss is a unique risk faced by liquidity providers (LPs) in decentralized finance (DeFi) when supplying assets to liquidity pools on automated market makers (AMMs). It occurs when the value of the tokens deposited in a liquidity pool changes compared to simply holding the tokens in a personal wallet.

Why It's Called "Impermanent"

This loss is termed impermanent because it only becomes realized if the LP withdraws funds from the pool while the asset prices have diverged unfavorably. If the prices return to their original ratio, the impermanent loss can decrease or even disappear.

How It Happens

Impermanent loss happens due to the way AMM protocols maintain a constant balance between paired assets (e.g., TON and USDT). When one asset's market price changes significantly relative to another, arbitrage traders rebalance the pool, which results in the LP holding a different proportion of tokens than initially deposited. This change can lead to a lower overall dollar value compared to simply holding the assets outside the pool.

Mitigation

LPs can offset impermanent loss by earning a share of the trading fees generated by the pool. However, if price volatility is large, the fees might not fully compensate for the loss. Understanding impermanent loss is crucial for anyone considering providing liquidity, as it impacts the profitability of liquidity mining strategies.

In summary, impermanent loss is the temporary difference in value between withdrawing assets from a liquidity pool and holding them outside, influenced by price volatility and pool mechanics.