Thread by @ThePalmTreeNW

1/7 Impermanent loss 💰is a common term in DeFi (decentralized finance) that refers to the temporary loss of funds that liquidity providers (LPs) may experience when they provide liquidity to a liquidity pool. 👇🧵

2/7 When LPs provide liquidity to a pool, they contribute funds to 🔁buy and sell two different tokens in a fixed ratio.

As the prices of these tokens fluctuate, the ratio of their values in the pool may change, resulting in a shift in the LP's portfolio composition.

3/7 This change in portfolio composition can lead to impermanent loss, which is the temporary reduction in the LP's portfolio value compared to if they had just held the tokens outside the pool. 💸.

For example:

4/7 If an LP provides liquidity to a pool with token A and token B in a 1:1 ratio, and the price of token A goes up ⬆️while the price of token B stays the same🟰, the LP's portfolio will now have more token B and less token A to balance the relation ⚖️

#liquiditypool

5/7💡This means that the LP's portfolio value, when measured in terms of token A, will be lower than if they had just held token A.

So, if the LP decides to withdraw their liquidity from the pool, they will receive less token A and more token B than they initially provided.

6/7 However, impermanent loss is only temporary, & the LP may still make a profit if the pool's trading fees compensate for the loss.

If we withdraw the funds from the pool when the token prices have returned to their original ratio, we will not experience any #impermanentloss

7/7 📃To summarize, the more stable you believe the tokens in the LP are, the lower impermanent loss you will experience.

However, these types of pools typically have lower revenue than others.

🧐Always do your own research (DYOR) and enjoy your #defi strategy.