LP Token

An LP token is a token issued to a liquidity provider as a receipt for their deposit into a liquidity pool, representing their proportional claim on the pool's assets and accumulated fees. When the provider wants their funds back, they return the LP token to the pool contract, which burns it and pays out their share of the reserves.

A concrete example: deposit ETH and USDC into a Uniswap pool and the contract mints you UNI-V2 LP tokens for that pair. If your tokens represent two percent of the pool, redeeming them returns two percent of the pool's current ETH and USDC. Because fees accrue inside the pool, each LP token gradually becomes redeemable for slightly more assets over time, assuming prices stay flat.

LP tokens are themselves ordinary tokens, which makes them composable: they can be transferred, used as collateral in lending protocols, or staked in yield farms to earn extra rewards. That flexibility cuts both ways — a common misconception is that staking an LP token elsewhere is risk-free extra yield, when in fact it adds a new layer of smart contract risk on top of the pool itself. Losing control of your LP tokens, whether through a hack or a malicious farm, means losing your claim on the underlying deposit.