What is Liquidity Providers (LPs)

Liquidity Providers (LPs) are participants in decentralised finance who deposit cryptocurrency assets into liquidity pools smart contracts that power decentralised exchanges and lending protocols. By supplying capital that enables others to trade, borrow, and interact with DeFi protocols, LPs earn a share of the fees generated by that activity.

THE LP VALUE PROPOSITIONDEXs

like Uniswap need pools of tokens for trades to execute against. Without liquidity providers depositing capital, there would be no tokens to buy or sell the DEX could not function. LPs solve this by locking their assets in pool contracts. In exchange, they receive a proportional share of every trading fee generated by their pool, plus any additional liquidity mining rewards from the protocol.

HOW TO BECOME A LIQUIDITY PROVIDER

Select a protocol and pool: Choose based on APY, TVL, volume, and your risk tolerance. Pools with high volume relative to TVL generate the most fees.
Prepare equal value of both tokens: Most AMM pools require you to deposit tokens at an equal dollar value. For an ETH/USDC pool at $3,500 ETH, you might deposit 1 ETH ($3,500) and 3,500 USDC.
Approve and deposit: Connect your wallet (MetaMask, Phantom), approve token spending, and call the addLiquidity function. Receive LP tokens representing your pool share.
Optionally stake LP tokens: Many protocols allow staking LP tokens in "farms" for additional governance token rewards on top of trading fees.

CALCULATING LP RETURNS

Return = (Trading fees earned) + (Additional token rewards) - (Impermanent loss) - (Gas costs).
At 0.3% fee on $5 million daily volume for a $10 million TVL pool: daily fee revenue = $15,000; your proportional daily earnings at 1% share = $150.
Annualised: $54,750 on a $100,000 position = 54.75% APY from fees alone (before impermanent loss).

CONCENTRATED LIQUIDITY (UNISWAP V3)

Uniswap V3 allows LPs to concentrate liquidity within a custom price range rather than spreading it across all prices. This dramatically increases capital efficiency earning similar fees with much less capital but requires active management as concentrated positions exit the active range when price moves outside the specified bounds.

Terms in addition to the Liquidity Providers (LPs)

Blockchain

A blockchain is a subset of a distributed database. The Bitcoin inventors originally prototyped the system in 2008. This modern database is made up of separate blocks that are connected together in a chronological chain. Blockchains may be used to store a wide range of data types. It has mostly been utilized as a public ledger for bitcoin transactions to date. A peer-to-peer network comprised of independent nodes uses a consensus process to ensure the blockchain's security and legitimacy. Each node in the network keeps a public and immutable copy of the data.

2 Factor Authentication (2FA)

2 Factor Authentication is a security measure with two layers. It is used by the majority of cryptocurrency exchanges. To log in, you must provide not only a password, but also a code obtained, for example, from the Google authenticator.

Airdrop

An airdrop is a method of distributing coins. End users can typically obtain coins for free or in exchange for doing a small task, such as subscribing to a newsletter, sending a tweet, or inviting others via a personal affiliate link. Cryptocurrency airdrops — the act of depositing cryptocurrency into public crypto wallets — are utilized as a marketing, liquidity creation, and network bootstrapping technique for many different types of blockchain initiatives.

Altcoin

Altcoin - "alternative coin" - is any kind of digital currency other than Bitcoin. Since the launch of Bitcoin, the world's first digital currency, many altcoins (as well as supporting blockchains) have been created. Altcoin digital currencies share many similarities to Bitcoin, but consistently and have significant differences. There are about 20,000 altcoins, and this number is expected to grow significantly in the coming years. Altcoins often develop Bitcoin features. Ethereum, currently the most widely used blockchain, supports digital contracts and separate applications where Bitcoin does not. Altcoins are also often created to cater to the needs of different users. The Litecoin blockchain, for example, can process payments quarterly for the duration of Bitcoin.

Cold Storage

Cold storage is the way to store cryptocurrency offline. The word refers to the use of offline wallets that are not connected to the internet. Cold storage is the most secure way to keep cryptocurrencies since an offline currency becomes less likely to be hacked and stolen. Paper wallets, printed renditions of private keys, and offline hardware and software wallets are all examples of cold storage.