Impermanent Loss
Short Description:
Tokenization is the process of transforming real-world assets or rights into digital tokens on a blockchain, making it possible to represent and trade items like real estate, art, or commodities as digital assets.
Main Description:
Impermanent loss is a concept that describes the temporary loss of value liquidity providers (LPs) might face when they contribute assets to a liquidity pool in decentralized finance (DeFi). This situation arises when the price of the assets they deposited changes significantly compared to their original value at the time of contribution.
When LPs add tokens to a liquidity pool, they earn a portion of the trading fees generated by that pool. However, if the price of one asset in the pool rises sharply relative to the other, LPs might find themselves with less overall value than if they had simply held onto their assets outside the pool. This occurs because automated market makers (AMMs) adjust the proportions of the assets in the pool to maintain liquidity, which can put LPs in a less advantageous position.
While LPs can offset some of this loss through the trading fees they earn, impermanent loss still poses a risk, particularly in volatile markets. The term “impermanent” highlights that this loss isn’t locked in until the LP withdraws their assets from the pool; if prices stabilize or revert, the loss may lessen or completely disappear.