What is LP token?

A token issued to a liquidity provider representing their share of a pool and the fees it has earned.

Redeeming it returns the underlying assets in whatever ratio the pool now holds, which is how impermanent loss is realized. LP tokens are themselves composable: many protocols accept them as collateral or as the deposit for a farming program, which stacks the pool's risk under a second contract.

Some designs issue a non-fungible position instead of a fungible token, because each concentrated range differs. The practical point for anyone holding one is that it is a claim on a moving basket, not a receipt for what you deposited.

How it works

When you deposit into a pool, the contract mints you tokens proportional to your share of it. Nothing records what you put in. The token records what fraction of the pool you own, and the pool's contents change with every trade.

Redemption returns that fraction of whatever the pool holds at the moment you withdraw, plus your share of the fees accrued since. If the two assets have diverged in price, the pool now holds more of the one that fell and less of the one that rose, so you receive a different mix than you deposited. That is the point at which divergence loss stops being a paper figure.

Because the token is transferable, it can be used elsewhere, and that composability is where most of the real risk enters.

1. Staked in a farming program to earn an additional token, which adds that program's contract to your exposure.
2. Posted as collateral to borrow against, which adds a liquidation threshold on top of a position whose value already moves with two assets at once.
3. Traded directly, since the token itself can have a market.

Each layer is a separate contract with separate failure modes, and a loss at any layer takes the underlying position with it.

Concentrated liquidity designs change the shape. A position defined over a price range is not interchangeable with another, so it is issued as a non-fungible position rather than a fungible token, and it stops earning fees entirely when the price leaves its range.

Example

Illustrative arithmetic. You deposit 1 ETH and 2,000 USDC into a pool at $2,000 and receive tokens representing 1 percent of it. ETH then doubles to $4,000. The pool rebalances through arbitrage, so your 1 percent now redeems for roughly 0.707 ETH and 2,828 USDC, worth about $5,657.

Had you held the two assets, you would have $6,000. The $343 difference is divergence loss, and it becomes real the moment you redeem. Fees earned over the period offset part of it, and whether they cover it depends entirely on how much volume the pool did.

Why it matters when you buy

This is decentralized exchange territory, and the number that matters when you simply want to buy an asset is what an order costs on the venues available to you. The liquidity view reports measured spreads, depth, and slippage per exchange, and the fee comparison covers all-in purchase cost. Centralized versus decentralized exchanges covers when each route makes sense.

Related terms

• liquidity pool: the contract the token claims a share of
• impermanent loss: what redemption realizes
• automated market maker: the rule that rebalances the pool
• concentrated liquidity: ranges issued as unique positions
• yield farming: staking the token for extra rewards
• nft: the form a concentrated position takes

Questions

Why did I get back different amounts than I deposited?

The pool rebalanced as prices moved, and your token claims a fraction of the pool rather than the specific assets you supplied. The mix returned reflects the pool's current ratio.

Can I lose an LP token?

It is a token like any other, so it can be sent to the wrong address or drained by a malicious approval. Losing it means losing the claim on the pool.

Does staking it somewhere increase risk?

Yes. Each additional protocol holding your position is another contract that can fail, and a loss there takes the underlying pool position with it.