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Impermanent loss occurs when traders exit the liquidity pool. In our previous example, if BTC increases in value more significantly than ETH, liquidity providers may find themselves in a position where they hold more ETH than BTC once the trading concludes. This asymmetry can lead to potential losses compared to simply holding the assets without providing liquidity.
Advantages of Liquidity Pools Over Traditional Trading Models
Despite their complexities, liquidity pools offer several advantages over traditional trading methods. In conventional trading, order books facilitate trades which require a balance of buyers and sellers at matched prices. Orders might exist at various price points, but unless buyers and sellers align, trades can't be executed.