Impermanent loss occurs when the price of tokens in a liquidity pool changes compared to when they were deposited. The loss becomes permanent only when liquidity is withdrawn.
How it works: LPs deposit two tokens at a 50/50 ratio, arbitrageurs rebalance the pool as prices change, LP share value differs from simply holding, and greater price divergence means greater IL.
Calculating impermanent loss: 1.25x price change results in 0.6% loss, 1.5x price change results in 2.0% loss, 2x price change results in 5.7% loss, and 5x price change results in 25.5% loss.
Mitigating impermanent loss: Choose stable pairs with correlated prices, consider concentrated liquidity positions, factor in trading fees earned, and use IL protection protocols.