Impermanent loss describes a liquidity position's value shortfall relative to a benchmark that simply retained the originally deposited assets, arising when relative prices change and the pool rebalances through trades. It is a comparison between two strategies, not necessarily an absolute loss in currency terms. Both strategies might gain value while the liquidity position gains less. The name can mislead: an economically meaningful shortfall exists while the position remains open, and withdrawing is not what creates the underlying difference.

Imagine a full-range constant-product position initially holding one unit of A and 100 units of B, with A priced at 100 B. If A doubles to 200 B and arbitrage adjusts the pool without fees, the position becomes approximately 0.7071 A and 141.42 B, worth 282.84 B. Holding the initial assets would instead be worth 300 B. The difference is about 17.16 B, or 5.72 percent of the holding benchmark. This example isolates the rebalancing effect rather than predicting a real pool's return.

Fees and incentive payments can offset some shortfall, while execution costs, contract failures, or a collapsing token can make the total outcome worse. Concentrated-liquidity positions have different exposure from the full-range example and can leave their active price range. Prices also need not return to their original relationship. A meaningful performance report states its benchmark, valuation currency, period, and treatment of fees. Reporting only fee income leaves out the changing value and composition of the assets used to earn it.