What is Impermanent Loss?

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When DeFi was built, most trading pairs were a pool of two tokens.

That’s why in most AMMs, Liquidity Providers are required to deposit 2 tokens in a 50:50 value ratio to a liquidity pool. 

When the tokens change in price relative to one another, rebalancing causes the pool to sell the token that is rising in price, so you end up with less of the rising tokens and more of the falling tokens. i.e. The legacy AMMs are selling tokens that perform better at a discount.

Over time, this causes the cumulative value of your pooled tokens to be worth less than if you simply held the two assets in your wallet.

 

Example:

If you stake ETH and USDC in a pool to provide liquidity, and if ETH price goes up, the protocol will sell your ETH, you will end up having more USDC and less ETH.

 

 

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