Liquidity Provision LP

Liquidity provision is the practice of depositing capital (two tokens as a pair) into an automated market maker (AMM) pool to enable trading. Liquidity providers (LPs) earn income from trading fees and token incentives. An LP providing $10k of ETH+USDC to Uniswap earns a small percentage of every trade between those tokens. Unlike traditional finance, AMMs use algorithms (constant product formula) to price assets without central order books. DeFi protocols depend on liquidity. LPs are the essential counterparty. As an LP, you can earn 5-50% APY (variable depending on volatility and protocol incentives). For investors with capital sitting idle, LP yield is meaningful income. The skill is critical for protocol designers and DeFi traders who want diversified income. However, LP returns come with risks: impermanent loss (if prices diverge) and smart contract bugs.