What is impermanent loss? Should I be worried?
DeFi offers a lot of benefits. Faster, cheaper transactions, transparency, a means to passive income through liquidity pools, and many more. Amid all this benefit lies one more concept — Impermanent loss.
What is impermanent loss?
Impermanent loss is a term in DeFi used to describe the potential loss of funds that comes from staking in a liquidity pool compared to holding the actual token. Also, impermanent loss only becomes a permanent loss when you make a withdrawal.
In providing liquidity to a pool, two tokens are required. An overall loss can occur due to the volatility of these assets. It is known as impermanent loss because it is only realised if funds are withdrawn.
Some liquidity pools are more exposed to impermanent loss than others. The rule is simple — the more volatile the assets are in the pool, the more likely you are to encounter impermanent loss. To get a rough estimate of what can happen in the pool, start by depositing small funds. The loss is only realised when the liquidity provider withdraws their liquidity and compares the difference in the asset price between the time of deposit and the time of withdrawal.
An impermanent loss might look simple with this explanation, but it is more complicated. One of our core focuses at Surehive is to reduce impermanent loss. You will learn more about this in future posts.