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Impermanent Loss

Impermanent loss (IL), also called divergence loss, is the difference between the value of assets held in an AMM liquidity pool versus simply holding them in a wallet, caused by price divergence between the paired assets. In a constant product AMM, when one token's price increases relative to the other, the pool rebalances by selling the appreciating token and buying the depreciating one — exactly the opposite of profit-maximizing behavior. The loss is 'impermanent' because if prices return to the original ratio, the loss reverses, but if the LP withdraws while the divergence persists, the loss becomes permanent. A 2x price change in one asset results in roughly a 5.7% loss relative to holding, while a 5x change results in about a 25% loss. Fee income can offset IL, and high-volatility pools often charge higher fees partly to compensate LPs for this risk. Protocols like Bancor have experimented with IL protection, and newer designs like Uniswap V4's hooks allow custom IL mitigation strategies.