What Is “Impermanent Loss” and How Is It Related to Transaction Costs for Liquidity Providers?
Impermanent loss is the temporary, unrealized loss a liquidity provider (LP) faces when the price of their deposited assets changes compared to simply holding them in a wallet. It is not directly a transaction cost, but it affects the LP's overall profitability.
LPs earn transaction fees to compensate for potential impermanent loss. High transaction costs can deter new LPs, but the fees LPs earn are their main offset against this loss.
Glossar
Impermanent Loss
LiquidityRisk ⎊ Impermanent Loss quantifies the temporary divergence in value between holding assets in a decentralized liquidity pool versus simply holding those same assets in a non-interest-bearing wallet, resulting from price movements between the deposited pair.
Transaction Fees
Cost ⎊ Transaction fees represent a quantifiable expense incurred for processing and validating transactions across diverse financial systems, functioning as a critical component of network participation and security.
High Transaction Costs
Constraint ⎊ High Transaction Costs, often manifesting as elevated gas fees on congested networks like Ethereum, impose a significant constraint on the economic viability of small-scale or frequent on-chain financial activities.