Put simply, impermanent loss (IL) reflects the $USD value loss in your holdings via the Liquidity Pool compared to your financial profit (or loss) had you simply held the assets in tokens, vs. adding them to the liquidity pool.
Said another way:
Impermanent loss occurs when the price ratio of the tokens a liquidity provider deposits in a liquidity pool change after they are deposited. It’s called “impermanent” because the ratio can return to the original amount if a user leaves the assets in the pool — the change becomes permanent when a liquidity provider removes funds from the pool.
The concept of Impermanent Loss can be rather complex. See our resource that focuses specifically on this topic to learn more.
Smart Contract Risk
Through decentralized finance, users are technically protected from having their assets managed my middlemen or other unknown figures, but funds are still guarded and “ruled” by the code within the smart contract. If the smart contract has vulnerabilities that are exploited, an LP and/or user’s funds may be lost forever.
Slippage is the difference between an asset’s expected executed trade price, and the actual executed trade price. Users experience the negative effects of slippage when using DEXs / Liquidity Pools with low levels of liquidity for their desired trading pair(s).
Traders or investors that have large order sizes are better off using popular DEXs with the highest liquidity to ensure the lowest possible slippage.
Misuse of Administrative Access / Keys
Sometimes, developers might have privileged access to the smart contract code. This presents an opportunity for malicious actors to take control of the funds / rug pull / exit scam. It’s important that DeFi investors do their research before placing assets in unknown DeFi protocols.
Binance Academy offers a beginner-level article on spotting scams in DeFi. Read it here.
Overall Market (Systemic) Risk
As with any new technology, investors in DeFi must stay vigilant of macro-economic, political, and industry events and general market momentum. Industries like DeFi often react more heavily than traditional markets, leading to increased volatility in cryptocurrencies. Always be aware of risk and manage it appropriately based on your own financial situation.