Tokens & Assets

LP Token

Liquidity Provider Token

Tokens representing a user's share in a liquidity pool

Definition

An LP token is the receipt for a share of a liquidity pool, redeemable at any time for a pro-rata slice of whatever the pool currently holds plus the fees it has accrued. In Uniswap v2-style pools it is a fungible ERC-20, so every holder's claim is identical and the token can itself be traded, staked or used as collateral. In Uniswap v3 each position has its own price range and is therefore an ERC-721 NFT rather than a fungible token. The important property is that an LP token tracks the pool's composition, not your original deposit: as the price moves, the pool rebalances against you and your claim converts toward whichever asset performed worse. Composability makes it a building block, since the same token can be staked in a gauge for emissions, deposited in an auto-compounder, or posted as collateral, with each layer adding another contract that has to hold.

An LP token is your claim ticket on a liquidity pool. Hand it back and you get your share of whatever the pool holds now, which is not the same mix you put in.

Example

You deposit $5,000 of ETH and $5,000 of USDC into a pool that already holds $1,000,000, giving you a 1% share and LP tokens representing it. If the pool earns $30,000 in fees over a quarter, your claim grows by roughly $300. But if ETH doubles over that period, the pool will have sold ETH into the rally on your behalf: your 1% now redeems for less ETH and more USDC than you put in, and against simply holding the two assets you are down about 5.7% before fees. That gap is impermanent loss, and the $300 of fees is what you were paid to accept it.

How it works

Deposit assets, receive LP tokens proportional to your share. Fees accrue into the pool, raising the value per LP token. Burn the tokens to withdraw your share of the current reserves.

Why it matters

It is the composable primitive the whole yield stack is built on: gauges, vaults, auto-compounders and collateral all take LP tokens as input, and each layer inherits the pool's risk plus its own.

What to check

Track the redeemable value against simply holding the two assets, not against your deposit. Check which contract actually holds the staked token, how the pool prices its assets, and how many layers you have stacked.

Risks to Consider

The redeemable value follows the pool's composition, so a divergence between the two assets leaves you holding more of the loser
Staked LP tokens sit in a second contract such as a gauge or vault, adding a failure mode on top of the pool itself
If one asset in the pool collapses or is paused, the LP token can become effectively unredeemable at any sane value
LP tokens used as collateral can be mispriced if the pool's own price is manipulable, which is a recurring flash-loan attack vector

Common Questions

How is an LP token's value calculated?

It is your share of the pool multiplied by the pool's current reserves, which means the price of both assets and the pool's composition both feed into it. Fees accrue by increasing the reserves per LP token rather than being paid out separately in v2-style pools, so the token quietly gets more valuable as volume flows through. For a v3 position the maths is range-dependent and the position can sit entirely in one asset.

Can I lose money holding LP tokens even if both assets go up?

Yes, relative to simply holding. If one asset rises much faster than the other, the pool sells the winner for the loser the whole way up, and you end up with less of the asset that performed. A 2x divergence costs a constant-product LP around 5.7% against holding, a 4x divergence about 20%. Fees have to make up that gap, which they sometimes do and often do not.

Why is a Uniswap v3 position an NFT instead of a normal token?

Because every v3 position has its own price range, so no two positions are interchangeable. A fungible token requires every unit to represent an identical claim, which stops being true once liquidity providers choose different ranges. The practical consequences are that v3 positions cannot be dropped into contracts expecting ERC-20 LP tokens, and that wrappers such as Gamma or Arrakis exist specifically to make range positions fungible again.

DeFi Glossary