Cryptocurrency liquidity providers: what they do and earn
A crypto liquidity provider supplies tokens so others can trade. Exchange LPs quote prices; DeFi LPs fund automated pools and earn a share of fees.
Vahe HakobyanEditor-in-chief
Updated Oct 5, 20263 min readFact-checked
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- Exchange LPs quote a buy and sell price.
- DeFi LPs deposit into automated pools.
- Share is deposit divided by pool liquidity.
- Returns hide contract risk and tax owed.
The term covers exchange and DeFi settings. On an exchange, the provider holds inventory and quotes prices. In DeFi, the provider adds tokens to an automated pool that a formula prices.
What is a crypto liquidity provider?
A liquidity provider keeps tokens available. In an automated market maker, providing liquidity is not lending. In a lending protocol, the term can mean a lender who deposits assets for borrowers.
How do order-book and AMM liquidity differ?
On an exchange, liquidity providers act as market makers and earn the gap between buy and sell prices. In DeFi, providers deposit tokens into automated pools, where a formula sets prices.
How is LP share calculated?
In many automated pools, deposits join one shared balance. Some designs use concentrated ranges or separate positions. Trading fees flow into that balance.
- Your share equals your deposit divided by total pool liquidity.
- Your earnings equal your share times the pool's trading revenue.
- A larger deposit raises your share if the pool stays the same.
- More trading raises revenue, but a larger pool splits it.
What does liquidity provider data miss?
LP tokens can be redeemed for your share, but impermanent loss can lower the value. Impermanent loss is the gap between your pool share and holding those tokens. LP returns do not show smart-contract risk, token volatility, or US tax owed on rewards.
Frequently asked questions
It is the gap between your pool share and holding the tokens. It happens when pooled token prices change relative to each other, and it can become permanent when you withdraw.
The IRS treats cryptocurrency as property. Liquidity mining rewards are generally taxable as ordinary income when received, while trading fees may be taxed differently.
Usually yes, if you hold the tokens and can reach an exchange or a DeFi pool. Exchange programs may require approval.
Staking usually locks tokens to help secure a blockchain. Providing liquidity puts tokens into a trading pool for a share of trading revenue.
