What Is the Concept of Impermanent Loss in Liquidity Provision?

Impermanent loss (IL) is the temporary loss of funds experienced by a liquidity provider (LP) due to the price change of the deposited assets relative to simply holding them in a wallet. It occurs when the price ratio of the two assets in the liquidity pool diverges from the ratio at the time of deposit.

If the price returns to the original ratio, the loss disappears, hence "impermanent." The loss becomes permanent only if the LP withdraws their funds while the price divergence exists. LPs accept this risk in exchange for trading fees.