What are Liquidity Provider Tokens (LP Tokens)?
Let's find out Liquidity Provider Tokens (LP Tokens) meaning, definition in crypto, what are Liquidity Provider Tokens (LP Tokens), and all other detailed facts.
Liquidity Provider Tokens (LP Tokens) track each contribution given to the overall liquidity pool since the amount of owned LP tokens corresponds to the liquidity share in the overall pool. They’re given to liquidity providers on decentralized exchanges (DEXs).
DEXs that issue LP tokens to liquidity providers include Uniswap, PancakeSwap, and Sushi.
In the most basic terms, LP tokens are very similar to tokens on the same network. For instance, Uniswap and Sushi operate on the Ethereum network. Therefore, LP tokens issued by these DEXs are considered to be ERC-20 tokens. Consequently, they can be transferred, traded, and staked on other protocols just like a regular ERC-20 token.
LP token holders have control over their locked liquidity, therefore, they can redeem LP tokens from the liquidity pools whenever they wish to do so. However, if they redeem them too early, they might face small penalties.
As mentioned above, LP tokens and the share in the overall liquidity pool are proportionate. This fact is utilized to find out:
- The transaction fees’ share accumulated throughout a liquidity provision per one liquidity provider;
- The percentage of liquidity when liquidity providers redeem their LP tokens.
You can calculate the value of an LP token using this formula:
Total Value of Liquidity Pool/Circulating Supply of LP Tokens = Value of 1 LP Token
In regards to DeFi platforms, more and more ways to use LP tokens are popping up.
For example, LP tokens are also used for farming which is a way to maximize rewards by staking LP tokens. Additionally, LP tokens can be used to qualify its holder to participate in an initial DEX offering (IDO). This is due to the fact that you must hold a certain amount of LP tokens that have a specific value in order to be eligible.