Liquidity Provider (LP)
- LP is used for Liquidity Provider and sometimes for Liquidity Pool.
- Liquidity pool — grouping together crypto assets and freezing them in a smart contract. Liquidity pools are used for decentralized trading, loans, and other endeavors.
- From this article (15-9-2020):
"A liquidity provider by definition is a market broker or institution which behaves as a market maker in a chosen asset class. What does it mean? The liquidity provider acts at both ends of currency transactions. He sells and buys a particular asset at certain prices."
- In crypto this comes down to providing a token or coin to a smart contract (the Liquidity Pool) on a DEX or other protocol in which other users can swap tokens.
- In return for providing tokens in this trading pool to make sure traders can do actual trading (the tokens being liquid instead of not having enough tokens to do trades with), many projects have started giving rewards to these liquidity providers. Uniswap is one of the first examples, giving UNI Pool Tokens which when held, gave holders rights to a proportionate percentage of the tx fees of that pool.
- This has grown into its own market economy of Liquidity Mining, in which users who provide tokens to a pool, get pool tokens in return, sometimes these tokens give dividends, sometimes they are purely meant for on-chain governance voting. Compound really kicked off this new frenzy back in June 2020.
Differences with Staking
"Staking is a slightly ambiguous term that can mean both things. In short, "staking" means locking up your assets in a smart contract. Generally, you stake your tokens in order to generate interest (yield) or to vote for the governance of a protocol.
Liquidity Providers "stake" their assets into pools in order to collect fees from the trades made by other users on the network.
Stakers earn fees primarily through block rewards, and are not necessarily exposed to market risks.
Liquidity providers earn returns from fees, proportional to the amount they stake. If you stake 100 tokens in an exchange pool that has a total of 1,000 tokens, you will own a 10% share of that pool. If an exchange charges a 0.3% fee to make a trade, you will collect 10% of that 0.3% fee. So, if a $10,000 trade is made, you will earn $3. LPs are exposed to market risks, and a large divergence in asset value can cause a loss of overall funds."