Liquidity Provider

A liquidity provider (LP) is a user who deposits tokens into a liquidity pool so that others can trade against them, earning a share of the pool's trading fees in exchange. LPs are the counterparties to every swap on an automated market maker: without their deposits, there would be nothing to trade against and no market.

A concrete example: a user deposits an equal value of ETH and USDC into a Uniswap ETH/USDC pool. Every time a trader swaps through that pool, a small fee is charged, and the LP earns a proportional slice based on their share of the total pool. If they supplied one percent of the pool's liquidity, they collect roughly one percent of its fees. When they withdraw, they receive their share of whatever assets the pool then holds, plus accumulated fees.

A common misconception is that providing liquidity is passive, risk-free yield. In reality, LPs face impermanent loss — when the two tokens diverge in price, the pool's rebalancing leaves the LP with less value than if they had simply held the tokens — and fee income may or may not offset that. LPs in volatile or thinly traded pairs can lose money overall, and pools containing a token that collapses in value pass that loss to their providers.