Have you ever heard of LP tokens (Liquidity pool)? If not you should read this article. Today we will talk about how to use LP tokens and what is LP. Let's find out!
What is LP (Liquidity Pool)?
LP tokens determine your share of fees incurred on transactions in the pool. In addition to releasing DEX liquidity, LP tokens have other uses. For example, you can use them to participate in Initial DEX Offerings (IDOs), as collateral for crypto loans, or to more earn returns through yield farming.
You can also use your LP tokens to compound interest on yield farms, take crypto loans, or transfer ownership of collateralized liquidity. However, it is important to understand that once you give up custody of your LP tokens, you do not actually own the associated liquidity.
How do LP tokens work?
Once you provide a pair of crypto assets to the liquidity pool, the DEX will automatically issue you LP tokens in proportion to the amount you deposited. For example, if you deposit $100 worth of assets into a $1,000 liquidity pool, you will receive 10% of the LP tokens in that pool.
The amount of LP tokens you own represents your value in this pool and will be used to claim any interest earned from the transaction. They are reflected on your crypto wallet and you can freely move them to different DeFi DApps to maximize your profits. When you withdraw LP tokens, you will lose your share of the liquidity pool.
How to use LP tokens?
Liquidity pool tokens are interesting as a token because they can be minted in a number of ways. Uniswap currently mints them as ERC-721 tokens, while SushiSwap mints them as (usually partial) ERC-20 tokens.
Suppose you deposit $2000 in stablecoins and 0.5 ETH into a liquidity pool. You have invested (at today's prices) about $4,000 into this pool. Suppose you get 200 liquidity pool tokens in exchange. Each of these tokens represents a proportional portion of your deposit, in this case $10 and 0.0025 ETH.
If you try to exchange these LP tokens directly to another currency (ETH, BNB, etc.) via the MetaMask Swaps tool or a third-party exchange platform, below things can be happened:
- Your tokens may get very low quotes
- If you swap on MetaMask Swaps, you may get a price unavailable warning as there aren't many people trading these tokens
- If you close the trade, you may end up with a very, very small portion of the value you originally put into the liquidity pool
- This will be irreversible; the blockchain cannot reverse any transaction, including these
- You cannot go back and remove your liquidity; you have traded your proof of ownership
So I hope now you will know what is LP and how to use LP tokens. The amount of LP tokens you own represents your value in this pool and will be used to claim any interest earned from the transaction. They are reflected on your crypto wallet and you can freely move them to different DeFi DApps to maximize your profits. When you withdraw LP tokens, you will lose your share of the liquidity pool.
