Impermanent Loss for Dummies

Impermanent Loss can happen when participting in LPs (liquidity pools). It happens when the value of your deposited tokens change over time after depositing them.

When you contribute to an LP, you usually get rewarded for doing so. You get a small cut of transactions made on that LP. Impermanent Loss is when the total value you earned from staking the token in an LP, is less than the amount you would have earned from just holding the tokens.

Example:

You add $500 A and $500 B (total $1000) at a 10% stake into a $10,000 A/B lquidity pool.

Lets say the value of A increases to $800, the pool becomes inbalanced and people will make their trades.

Now the pool is balanced again at $12,000. You decide to withdraw your 10% of the stake. You now have $1200 ($200 profit).

This looks like good profit. You made $200. However, if the value of token B stayed the same at $500, and token A is $800, you actually would have pulled out $1300 (800 + 500) , or $100 MORE if you hadn't contributed to the LP, and just held the tokens in your wallet instead. This is what we call impermanent loss.

We can calculate impermant loss with this forumla

Impermanent Loss = PoolValue (USD) / Hold Value (USD) - 1 (multiply result by 100 for percentage)

contributing to LP with alt coins or volatile coins can often lead to impermanent loss. The best way to avoid impermanent loss would be to contribute to LP with stable coins or more stable assetts like BTC or ETH to reduce the level of impermanent loss.

I hope this makes it less confusing. I know it can be hard to visualize this complex topic with just words. There are plenty of videos on youtube explaining it with pictures and videos. It's important to understand this and know what you are doing with your money.