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In the world of decentralized finance (defi), liquidity pools and yield farming are highly profitable means of passive income. However, the biggest and most complex technical risk for liquidity providers (LPs) in this system is called impermanent loss. Simply put, if you had not deposited your cryptocurrencies in a liquidity pool and simply left them idle or held in your personal wallet, the difference in relative loss or lower profit compared to depositing them in the pool is called impermanent loss. The main reason for this loss is the extreme volatility of cryptocurrencies in the market and the mathematical equilibrium principle of AMMs or automated market makers. As we know, a liquidity pool usually consists of two different tokens (e.g. eth/usdt) in an equal price ratio (50:50). After depositing the two tokens in the pool, if the price of one of the tokens changes dramatically in the external open market (it can increase or decrease a lot), then a discrepancy is created between the price inside the liquidity pool and the price in the external open market. At this opportunity, arbitrage traders (Arbitrageurs) buy tokens from the external low-priced market and sell them at a higher price in the liquidity pool, or withdraw cheap tokens from the pool and sell them at a higher price outside. This process continues until the price inside the pool is equal to the external market again. But as a result of this continuous price change, the actual ratio or number of tokens in your pool changes according to the mathematical formula of the AMM. When you go to withdraw your funds from the pool completely, you will see that the price of the token has increased a lot, the number of that token in the pool has decreased and the number of the other token has increased. This results in your overall portfolio value being less than if you were to simply hold the two coins outside. This loss is called ‘impermanent’ because as long as your funds are locked up in the pool, the loss is only on paper or virtually. If for some reason the market price ratio of the two coins returns to exactly the price at which you deposited the tokens into the pool, this loss is completely erased and the loss becomes zero. But if you withdraw your tokens from the pool amidst this large price difference, this temporary loss turns into a permanent loss. In short, permanent loss is an inevitable tax on providing liquidity in the DeFi market. The main way to avoid this risk is to avoid highly volatile coin pairs and provide liquidity in stablecoin pairs (e.g. USDC/USDT), where there is no chance of changing the price ratio. Before investing as a liquidity provider, you should always remember that investing in this liquidity pool will only be profitable for you in the long run if the trading fees and bonus rewards received from the pool are higher than the impermanent losses. Today's discussion concludes here. I hope you've found it interesting. Please share your thoughts on today's topic. Prayers for everyone. May everyone be well. Amen.