Liquidity Provider

A liquidity provider (LP) is anyone who deposits crypto assets into a trading venue so that other users can buy and sell against that supply. On centralized exchanges this role is filled by professional market makers quoting order books, but the term is most closely associated with decentralized finance, where LPs fund the liquidity pools that automated market maker (AMM) protocols such as Uniswap use to price and execute swaps without a traditional order book.

In practice, an LP deposits two tokens at a set ratio into a pool's smart contract and receives LP tokens back, a receipt representing their proportional share of the reserves. Every swap routed through the pool pays a small fee, which is distributed to LPs according to their share, and can be claimed by later burning the LP tokens to withdraw the underlying assets plus accrued fees. Newer AMM designs, pioneered by Uniswap v3, let LPs concentrate their capital within a chosen price range rather than spreading it across all possible prices, boosting fee income when the market stays inside that range but leaving the position idle once it moves out.

The main risk is impermanent loss: if the two deposited assets diverge in price, the pool automatically rebalances the holdings, and the LP can end up with less value than simply holding the original tokens, a loss that becomes permanent only on withdrawal. Additional incentive programs, often called liquidity mining, pay extra token rewards to attract deposits into new or thinly traded pools.