Impermanent loss

Impermanent loss is the gap between what your tokens are worth inside an automated market maker pool and what they would be worth if you had simply kept them in your wallet. It appears when you deposit two assets into a liquidity pool and their relative price changes. The word "impermanent" means the gap shrinks if the price ratio returns to where it was when you deposited, but it becomes permanent the moment you withdraw at a different ratio.

Mechanically, a standard constant-product pool keeps the product of its two token balances constant, and arbitrageurs trade against it until the pool price matches the wider market. If one token rises, traders buy it from the pool, so the pool ends up holding less of the winner and more of the other token. You are effectively selling the token that is going up and buying the one that is going down, automatically. The loss depends only on how far the price ratio moves, not on direction: a 2x move in either direction costs roughly 5.7% versus holding, and a 5x move costs about 25.5%.

Trading fees are what is supposed to pay you for taking this on. If the fees you earn exceed the loss, you come out ahead of holding; if they do not, you would have been better off doing nothing. For small tokens the problem is severe, because a new token paired with SOL, ETH, or a stablecoin can rise 10x or fall to near zero. In the second case the pool ends up almost entirely made of the dead token. Pools of two stablecoins, or of two assets that track each other, suffer far less.

Watch for advertised yields that count reward tokens at a volatile market price and ignore impermanent loss entirely. Compare a pool's trading volume to its liquidity, since fees only come from volume. Check whether the liquidity is locked and whether the token has sell restrictions, because a pool you cannot exit is a bigger problem than the loss itself. Concentrated-liquidity positions amplify both the fees and the loss, and they stop earning when the price leaves your chosen range.