Impermanent loss occurs when the price of assets you’ve deposited into a liquidity pool diverge significantly from when you first deposited them. It’s “impermanent” because if the prices return to their original state, the loss disappears—unless you withdraw in the meantime.
When you provide liquidity to a decentralized exchange like Uniswap, your assets are rebalanced constantly to maintain a 50/50 ratio. If one asset appreciates rapidly while the other stays flat or declines, your overall gains might be less than simply holding the asset.
Impermanent loss is one of the biggest risks for liquidity providers and is often underestimated by new DeFi users. Protocols have begun offering incentives (like yield farming rewards) to offset this loss, but it’s a crucial concept to understand before jumping into DeFi.
