Impermanent Loss

Impermanent loss is the gap liquidity providers take when the price ratio of paired assets moves away from the ratio at deposit. Deposit 1 ETH and 1000 USDC when ETH is $1000. If ETH rises to $2000, the constant product rule, x * y = k, rebalances the pool. You hold more of the cheaper asset and less of the expensive one. You might have 0.7 ETH and 1400 USDC.

If you had held the original tokens you would have 1 ETH worth $2000 plus $1000 USDC, total $3000. Instead you have about $2800. That gap is impermanent loss. It is called impermanent because if prices return to the original ratio, the gap closes. Traders who expect mean reversion can accept it. Long-term holders feel it as a drag. More volatile pairs lose more. Stablecoin pairs barely move.

Concentrated liquidity can cut the loss by keeping capital inside an expected price range, at the cost of going inactive if price leaves that range. If ETH rises to $2000, the constant product formula forces the pool to maintain x * y = k. If prices diverge, an AMM LP can hold less value than if they had just kept the tokens. Fees may or may not cover that gap.