What Is the Core Mechanism of an Automated Market Maker (AMM) That Causes Impermanent Loss?

The core mechanism is the constant product formula, typically x y = k. This formula ensures that the pool always maintains liquidity by adjusting the token prices based on the ratio of tokens in the pool.

When an external market price changes, arbitrageurs trade with the pool to bring its internal price in line with the external price. This trading activity changes the token ratio, causing the value of the deposited assets to diverge from the value of simply holding the initial assets, which is the definition of impermanent loss.