Glossary · L
Liquidity Provider
A user who deposits tokens into a DeFi liquidity pool or lending market to provide capital for trading or borrowing. In AMMs, LPs deposit token pairs (e.g., ETH and USDC) into a pool and earn trading fees in return. In lending protocols, LPs (suppliers) deposit single assets and earn interest from borrowers. LPs take on risks including impermanent loss (for AMMs), smart contract risk, and counterparty risk (for lending).
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How Liquidity Provider works in practice
A liquidity provider deposits assets into a pool so others can trade against them, earning a share of fees in return. In an AMM the LP is taking the other side of every trade automatically, which is why the position accumulates whatever the market is selling.
Worked example
Providing 1% of a pool that generates 100,000 in monthly fees earns 1,000 a month. Against that sits impermanent loss from the pair diverging — the position is profitable only if fees exceed it.
Figures are illustrative and chosen to be checkable, not live market data.
The mistake that costs people money
Providing liquidity is a strategy with a specific payoff, not a savings account. It performs well in range-bound markets with high volume and badly when one asset trends hard against the other.
Liquidity Provider: common questions
- What is Liquidity Provider?
- A user who deposits tokens into a DeFi liquidity pool or lending market to provide capital for trading or borrowing. In AMMs, LPs deposit token pairs (e.g., ETH and USDC) into a pool and earn trading fees in return. In lending protocols, LPs (suppliers) deposit single assets and earn interest from borrowers. LPs take on risks including impermanent loss (for AMMs), smart contract risk, and counterparty risk (for lending).
- How does Liquidity Provider work in practice?
- A liquidity provider deposits assets into a pool so others can trade against them, earning a share of fees in return. In an AMM the LP is taking the other side of every trade automatically, which is why the position accumulates whatever the market is selling.
- Can you give an example of Liquidity Provider?
- Providing 1% of a pool that generates 100,000 in monthly fees earns 1,000 a month. Against that sits impermanent loss from the pair diverging — the position is profitable only if fees exceed it.
- What do people get wrong about Liquidity Provider?
- Providing liquidity is a strategy with a specific payoff, not a savings account. It performs well in range-bound markets with high volume and badly when one asset trends hard against the other.