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LP Token

A token or accounting unit representing a user’s proportional ownership of assets deposited into a liquidity pool.

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Definition

A token or accounting unit representing a user’s proportional ownership of assets deposited into a liquidity pool.

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Why it matters

DeFi concepts explain blockchain-based markets, lending, trading, liquidity, and financial automation.

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How it works

When a user deposits crypto, the smart contract calculates the proportion of the pool owned by the user. It then mints unique LP tokens representing that percentage stake. When a withdrawal is requested, the contract burns the tokens and transfers the pro-rata value back to the user’s wallet.

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Real-world example

On SushiSwap, providers receive SLP (Sushi Liquidity Provider) tokens after depositing assets into a trading pool.

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Advantages

  • Provides proof of ownership for deposits
  • Enables easy tracking of earned trading fees
  • Can be used in other DeFi protocols

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Limitations

  • Value fluctuates with pool assets
  • Requires technical knowledge to track
  • Risk of loss if the token is transferred incorrectly

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Common misconceptions

  • Some think LP tokens are standard currency to be traded on exchanges. They are specific to the protocol that issued them.
  • Many users forget that LP tokens represent a fluctuating share, not a fixed amount of coins.
Canonical knowledge ID: glossary:lp-token