LP Tokens
DeFi Instruments, Yield Model
LP Tokens (Liquidity Provider Tokens) are blockchain tokens that represent a user’s share in a liquidity pool on a decentralized exchange (DEX) or automated market maker (AMM). When you provide assets (like ETH/USDC or FLR/sFLR) to a liquidity pool, you receive LP tokens in return. These tokens can be staked for additional rewards, traded, or redeemed to withdraw your share (plus fees earned) from the pool.
Use Case: On Uniswap, a user adds ETH and USDC to a pool and receives UNI-V2 LP tokens. These can then be staked in a yield farm for bonus rewards or redeemed later to reclaim the user’s share of both tokens plus a share of all trading fees generated by that pool.
Key Concepts:
- Liquidity Pool — The source of funds that LP tokens represent.
- Yield Farming — Earning additional returns by staking LP tokens in specialized contracts.
- Impermanent Loss — The risk that affects LP token value when token prices shift unevenly.
- Swap Fee — The share of trading fees distributed to LP holders.
Summary: LP tokens turn liquidity provision into a tradable, flexible asset. They’re key to earning passive income, accessing DeFi rewards, and representing ownership in Web3’s open financial markets.