Liquidity pools & becoming an LP

So far you've traded against liquidity pools. Now you can supply one. Becoming a liquidity provider (LP) is how you earn a share of the fees every swap pays — and your first real taste of DeFi yield.

How it works

You deposit a pair of tokens into a pool — classically in equal value, like $500 of ETH and $500 of USDC. Traders swap against your liquidity, and the pool's fee (Lesson 16) is shared among all providers in proportion to their share. The more the pair trades, the more you earn.

LP tokens: your receipt

When you deposit, the pool issues LP tokens representing your share. They're your claim on the underlying assets plus accrued fees; you burn them to withdraw. Treat them carefully — they are your position.

Concentrated liquidity

Older pools (Uniswap v2 style) spread your liquidity across all prices. Newer concentrated liquidity (Uniswap v3) lets you focus it in a price range you choose, earning far more fees per dollar while the price stays in range — but earning nothing, and being fully exposed, when it drifts out. Powerful, and more hands-on.

The risks, plainly

• Impermanent loss — if the two tokens' prices diverge, you can end up worse off than just holding them. Important enough to get its own lesson, next.
• Smart-contract risk — your funds sit in a contract; a bug or exploit can affect them.
• Token risk — providing liquidity for a bad token can leave you holding the worthless side.

Is it "passive income"?

Sort of — fees accrue without effort, but the risks are real and concentrated positions need monitoring. A sensible starting point is a deep, blue-chip pool (a major stablecoin pair) where divergence risk is low. Chase a giant advertised APY on an obscure pair and impermanent loss or a rug can erase it. Understand the next lesson before committing real size.