Liquidity Provider (LP) Token

When a user deposits assets into a liquidity pool, the protocol mints and hands back a matching quantity of LP tokens on the spot. These are not a fixed 1:1 receipt: the amount issued depends on the depositor's share of the pool's total value at that moment, so the same dollar deposit can yield very different token counts in a small pool versus a deep one. Most LP tokens follow a standard fungible format, such as ERC-20 on Ethereum, which is what allows them to be transferred, traded, or plugged into other protocols rather than sitting inert in a wallet.

Holding the token is what proves ownership: whoever controls it can burn it later to withdraw their portion of the pool's assets plus the trading fees that accrued while they were staked, typically a fraction of a percent per swap. Because the token itself carries that claim, losing it, whether through a lost wallet, a phishing scam, or sending it to the wrong address, means losing access to the underlying funds, even though the deposit is still technically sitting in the pool.

Their real utility in DeFi comes from composability. Rather than leaving capital idle, holders commonly:

• Stake LP tokens in a separate yield farming contract to earn a protocol's native token on top of trading fees.
• Pledge them as collateral on lending markets to borrow other assets without unwinding the original position.
• Use them for governance voting on the platform that issued them.

This stacking of rewards raises the risk profile alongside the yield. Impermanent loss, the gap between holding assets outright versus supplying them to a pool where prices diverge, erodes value even before any smart contract failure or rug pull is considered, and using LP tokens as collateral adds liquidation risk on top.