What is Impermanent Loss?
The possibility of impermanent loss is one of the risk associated with liquidity pools. This happens when there are variations in the price ratio of pooled assets. When an LP's investment price differs from the price at which he placed the funds, he will immediately lose money. The loss incurred increases with the magnitude of the price shift. Pools with variable pricess by LP are often vulnerable to impermanent losses.
This loss is only temporary because there's a chance the price ratio will go back. Only if the LP removes the specified funds prior to the price ratio reverting will the loss become irreversible. Be aware that sometimes these losses can be offset by the possible profits from LP token staking and transaction fees.
Example:
A liquidity provider adds an equal value of two tokens to a pool, for example, ETH and DAI.
The price of the tokens changes, causing the ratio of the tokens in the pool to change.
If the price of one token increases significantly compared to the other, the pool will have more of the token that decreased in value, and less of the token that increased in value.
When the liquidity provider withdraws their tokens from the pool, they end up with fewer tokens of the appreciating asset and more of the depreciating asset than they initially deposited, resulting in a loss compared to holding the tokens.