LP Token

An LP Token is a fungible token minted by an Automated Market Maker (AMM) protocol, such as Uniswap or Curve, when a user deposits assets into a liquidity pool. It acts as a verifiable, on-chain claim to the underlying assets and the accrued trading fees. The quantity of LP tokens a user receives is proportional to their contribution relative to the total pool liquidity. For example, depositing 1 ETH and 3,000 USDC into a Uniswap V2 pool would yield a specific amount of UNI-V2 LP tokens, which can later be burned to redeem the deposited assets plus a share of the fees.

The primary function of an LP Token is to enable non-custodial proof of ownership. It allows liquidity providers to withdraw their proportional share of the pooled assets at any time, while also facilitating complex DeFi interactions. These tokens are themselves ERC-20 standard tokens (or their equivalent on other chains), making them transferable and composable. This means LP tokens can be staked in other protocols for additional yield, used as collateral for borrowing, or traded on secondary markets, a concept known as LP token composability.

The value of an LP Token is derived from the underlying assets in the pool and the accumulated fees. Its price is not static; it rebases or changes in quantity as fees are added to the pool, increasing the total value claimable per token. This mechanism differs from traditional finance, where a share certificate has a fixed nominal value. The smart contract uses a constant product formula (x * y = k) or other invariant to manage the pool, and the LP token represents a claim on a portion of the reserves x and y.

Key risks associated with holding LP tokens include impermanent loss, which occurs when the price ratio of the deposited assets changes compared to holding them separately, and smart contract risk. The token's utility is central to the liquidity mining and yield farming ecosystems, where protocols distribute governance tokens as rewards to users who stake their LP tokens. This creates a layered yield structure: fees from trading activity plus additional incentive tokens.

In summary, an LP Token is the fundamental financial primitive of decentralized finance liquidity provision. It transforms locked capital into a productive, programmable, and transferable asset, enabling the trustless exchange mechanisms that power DEXs and the broader DeFi economy. Understanding LP tokens is essential for engaging with AMMs, yield optimization strategies, and the composable nature of DeFi money legos.

A Liquidity Provider (LP) Token is a fungible digital receipt minted and issued to a user who deposits an equal value of two assets into an Automated Market Maker's (AMM) liquidity pool. This token is a claim on the depositor's proportional share of the pooled assets and any accumulated trading fees. Holding the LP token is the sole proof of ownership; without it, the deposited funds cannot be reclaimed. The token's quantity represents the holder's stake, which grows as fees accrue and shrinks from impermanent loss if the asset prices diverge.

The primary function of an LP token is to enable non-custodial ownership and composability. Because it is a standard token (often an ERC-20 or SPL token), it can be freely transferred, traded, or used as collateral in other DeFi protocols—a concept known as "money Lego." For instance, a user can deposit their UNI-V2 LP tokens into a lending platform like Aave to borrow against them, or stake them in a yield farming program to earn additional token rewards. This transforms static liquidity into a productive, yield-generating asset.

The value of an LP token is dynamic and derived from the underlying assets in the pool. Its price per token is calculated as the total value of the pool (including accrued fees) divided by the total LP token supply. Users "burn" their LP tokens to redeem their share of the pool, receiving both underlying assets back. This redemption process automatically calculates their portion of the accumulated trading fees, which are seamlessly added to the returned assets, making fee collection passive and automatic upon withdrawal.

An LP Token (Liquidity Provider Token) is a digital asset minted and issued to a user who deposits funds into a decentralized exchange (DEX) liquidity pool, serving as a receipt and proportional claim on the pooled assets and any generated fees. The fundamental distinction lies in whether this token is fungible, meaning identical and interchangeable like the ERC-20 standard, or non-fungible, meaning unique and distinct like the ERC-721 or ERC-1155 standards. This design choice by the protocol dictates how liquidity positions are tracked, managed, and potentially enhanced with additional data.

Fungible LP Tokens, such as those used by Uniswap V2 and many Automated Market Makers (AMMs), are uniform. All tokens for a given pool are identical, with each unit representing an equal, fractional share of the entire pool. A user's share is calculated simply by the quantity of LP tokens they hold relative to the total supply. This model enables seamless composability, allowing these tokens to be freely traded, used as collateral in other DeFi protocols, or deposited into yield aggregators without complexity. Their uniformity makes them highly liquid but limits the ability to attach unique attributes or conditions to individual positions.

Non-Fungible LP Tokens (NFTs), pioneered by Uniswap V3, represent concentrated liquidity positions. Each NFT is a unique data structure encoding the specific parameters of a liquidity deposit, most critically its price range. This allows liquidity providers (LPs) to allocate capital within a custom price interval, potentially earning higher fees on that capital if the price stays within the range. The NFT functions as a detailed ledger entry, tracking the unique performance and fees accrued by that specific position. While this enables sophisticated strategies, it reduces fungibility as each position's value is distinct, complicating direct token-for-token swaps.

The choice between models involves trade-offs between capital efficiency and fungibility. Fungible tokens offer simplicity and deep integration across DeFi but may lead to idle capital spread across the entire price spectrum from zero to infinity. Non-fungible tokens enable precise, capital-efficient market making but introduce complexity in management and secondary market liquidity. Some newer protocols employ hybrid models, using semi-fungible ERC-1155 tokens to batch similar positions or wrapping NFT positions into fungible vault tokens to regain composability.