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2. Intermediate Course

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  1. 1. Ethereum 2.0 - What is it? 
  2. 2. What is cryptocurrency burning?
  3. 3. How to create your own cryptocurrency? 
  4. 4. Blockchain Oracle - what are oracles? 
  5. 5. How to make money with NFT?
  6. 6. What is an ERC20 token and how is it created?
  7. 7. The Metaverse – a new virtual world
  8. 8. Metaverse – TOP 15 virtual reality projects
  9. 9. Technical analysis – is it worth using?
  10. 10. What are DeFi liquidity pools?
  11. 11. Second layer (layer 2) - what is it? 
  12. 12. What are wrapped tokens 
  13. 13. What is the Lightning Network, and how does it work?
  14. 14. What are security tokens?
  15. 15. What is Play-to-Earn (P2E) and how does it work?
  16. 16. What are Social Tokens? 
  17. 17. Examples of the use of WEB3 on the blockchain
  18. 18. What is Web5? 
  19. 19. Ethereum London Hard Fork - what is it ? 
  20. 20. Segregated Witness - what is Segwit Bitcoin all about?
  21. 21. Polkadot - Decentralized blockchain and DOT cryptocurrency
  22. 22. Polkadot Parachain - Next-generation blockchain
  23. 23. Trading order types: stop loss, trailing stop loss, LIMIT
  24. 24. Set up of Stop Loss and Take Profit orders
  25. 25. What are Decentralized Cryptocurrency DEX Exchanges?
  26. 26. What is Curve Finance?
  27. 27. What is GameFi and how does it work?
  28. 28. Non-fungible tokens and NFT exchanges
  29. 29. Cryptocurrency steps - What is move to earn M2E?
  30. 30. What is Proof of Reserves (PoR)? How does it work?
  31. 31. Interoperability in the world of cryptocurrencies and blockchain
  32. 32. Blockchain and its layers - What is layer three in Blockchain (L3)?
  33. 33. What is Layer 0 in Blockchain technology?
  34. 34. What is layer 1 in Blockchain?
  35. 35. What is MakerDAO and DAI Stablecoin?
  36. 36. What is Blockchain sharding?
  37. 37. What is the NFT licence fee?
  38. 38. What is the SubDAO protocol, and how does it work?
  39. 39. The main differences between static NFT and dynamic NFT
  40. 40. What is minting an NFT?
  41. 41. Mainnet versus Testnet on the Blockchain. The complete guide!
  42. 42. What are NFT Ordinals? A guide to Bitcoin NFT.
  43. 43. Market Cap versus Fully Diluted Market Cap - the most important differences you should know!
  44. 44. MINA Protocol: the lightest blockchain in the world!
  45. 45. NFT Gas Fee - what is it? How can you reduce your gas fee?
  46. 46. Liquidity Provider Tokens (LPs). What are they, and why are they so important?
  47. 47. What is KnowOrigin NFT, and how does it work?
  48. 48. What is decentralized social media?
  49. 49. What is the Ethereum Name Service (ENS) and how does it work?
  50. 50. Arbitrum: Ethereum scaling solution - everything you need to know
  51. 51. Ethereum ERC-4337 - what is it and how does this standard work?
  52. 52. Sustainable Blockchain - Proof of Useful Work & Flux
  53. 53. Ethereum Proof-of-Stake (PoS) - what should you know?
  54. 54. Atomic Swap: What is an atomic swap, and how does it work with cryptocurrencies?
  55. 55. What Is Cryptocurrency Vesting? What Are Its Advantages?
  56. 56. What Is the Metaplex Candy Machine Protocol? How Does It Work?
  57. 57. What Is the BNB Greenfield Ecosystem?
  58. 58. Real Yield in DeFi - what is this trend? What does it consist of?
  59. 59. What Is Slashing in Cryptocurrencies?
  60. 60. How to Create Your Own Decentralized Autonomous Organization (DAO)?
  61. 61. The ERC-721X VS ERC-721 Standard – Key Differences!
  62. 62. Royalties – What Are They? How Does This Type of Licensing Fee Work?
  63. 63. Polygon 2.0 - the value layer for the Internet
  64. 64. ERC-6551 - the new NFT standard. What does it bring to the non-exchangeable token sector?
  65. 65. What is TradFi? The importance for cryptocurrencies!
  66. 66. What is the Real World Asset (RWA) trend in cryptocurrencies? Explanation and examples!
  67. 67. Pyth Network: a powerful oracle harnessing the power of Solana!
  68. 68. Vampire Attacks in Decentralized Finance (DeFi): Explanation and Examples
  69. 69. What are stables in the world of cryptocurrencies?
  70. 70. What Is Binance Oracle?
  71. 71. What is NFT Lending all about? An innovative solution in the world of cryptocurrencies!
  72. 72. Shibarium: A new era in the Shiba Inu ecosystem?
  73. 73. What is an ETF? How will an exchange-traded fund on bitcoin work?
  74. 74. Symmetric and asymmetric encryption - key cryptography techniques!
  75. 75. Cosmos SDK: Building the Blockchain Ecosystem
  76. 76. DAO Investment: A revolution in the world of finance and investment
  77. 77. What is cross-chain interoperability in Blockchain technology?
  78. 78. Blockchain trilemma - explanation of the problem. What is the impact on cryptocurrency payments?
Lesson 46 of 78
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46. Liquidity Provider Tokens (LPs). What are they, and why are they so important?

Liquidity Provider Tokens, abbreviated as LP Tokens, are tokens that are part of a reward mechanism that facilitates transactions between different types of cryptocurrencies.

Decentralized exchanges rely heavily on liquidity providers to ensure an always-active market for digital assets. Whenever a liquidity provider deposits cryptocurrency into the liquidity pool, it receives Liquidity Provider tokens in return. So we can say that they represent the amount that the liquidity provider deposits into the total liquidity pool.

We also have to admit that LPs have become quite popular in the Web3 trend and ecosystem. Especially when we consider them in the context of decentralized finance (DeFi), which we wrote about here.

Today we will focus on liquidity providers and better understand how they function in the overall digital asset system.

Liquidity providers – who are they?

To understand what Liquidity Provider tokens are, we first need to clarify what liquidity providers and AMMs are.

Liquidity providers are investors who provide a certain pool of cryptocurrency assets to the liquidity pool. In return for their activity, they receive rewards.

There are various liquidity pools in the cryptocurrency ecosystem, but the most popular are those on DEX. Liquidity providers earn through trading fees paid by investors to DEX for each transaction. Interestingly, some DEX also reward providers with management tokens for their contribution and participation in the overall liquidity pools. The process we mention here is called liquidity mining.

Automated Market Makers (AMM).

They are used in most DEX to facilitate transactions. AMMs are mainly protocols or algorithms that cut out middlemen and order books from the whole process.

AMMs offer full autonomy and use smart contracts for their operation. Each cryptocurrency pair has its liquidity pool to which anyone can contribute liquidity.

Each liquidity pool is balanced. There are appropriate mathematical equations that prevent drastic price changes in cryptocurrencies.

How do Liquidity Provider tokens work?

Now that you know what liquidity providers do and the importance of AMM in the ecosystem, we can focus on how LP works.

LP tokens have one main role – to increase liquidity in the DeFi ecosystem. Liquidity is the flexibility to convert cryptocurrency assets into other assets without affecting their price.

Liquidity provider tokens are very similar to other tokens. They can be transferred, traded or even staked on other protocols. Therefore, liquidity providers have control over locked assets in liquidity pools.It should be noted that the LP tokens also determine the share of the transaction fees, which represent the remuneration of the liquidity providers.

LP tokens represent the liquidity provider’s share of the liquidity pool. Providers have full control over these tokens. Example: If you add $10 to a liquidity pool of $100, you can expect about 10% of the LP token share of that liquidity pool. In return, you get 10% of the LP tokens, as you own 10% of the total liquidity pool. You can imagine that these tokens are a kind of “credential” for the entire pool.

Liquidity Provider Tokens can be staked to earn more rewards (yeld). These, of course, come in the form of new tokens. LP staking shows that a particular provider is committed to supporting LP tokens. This affects the market price of the tokens in question.

Furthermore, this type of token plays an important role in the Initial DEX Offering (IDO). The Initial DEX Offering is a fundraising model in which a project or start-up raises money by relying on its tokens via DEX. In this model, the LP tokens are locked for new tokens offered by the project.

Yeld Farming and staking Liquidity Provider Tokens

Yeld farming is a strategy for investing one’s cryptocurrency assets, where investors use their assets between different pools of liquidity. All with the aim of maximizing their profit or increasing their return share.

An example of this is Compound, which awards its COMP management token to all its users for lending and borrowing while increasing the level of activity in the ecosystem. In this case, liquidity providers earn from users’ transaction fees.

Another revenue opportunity for liquidity providers is staking. Currently, many platforms allow liquidity providers to stack their LPs. They can then earn even more interest on these tokens. However, when stacking, you need to keep in mind the possibility of losses. This can occur if the value of the assets in the liquidity pool is less than the value stored in the cryptocurrency exchange.

Examples of Liquidity Provider Tokens

  1. There are several decentralized exchanges in the cryptocurrency ecosystem that are responsible for distributing LP tokens. Let us take a look at two of the biggest:

Uniswap. It is a fully automated liquidity protocol built on the Ethereum blockchain. Every smart contract on the network manages a liquidity pool consisting of reserves of two ERC-20 tokens. With this ecosystem, anyone can become a liquidity provider as long as they deposit the equivalent value of each underlying token in exchange for tokens from the pool.

Curve – is also a fully automated market maker. The Curve liquidity pool allows investors to buy new LP tokens and stake them in exchange for a CRV token. In this way, liquidity providers offer an additional layer of utility and profit for initial investments.

Risks associated with LP tokens

There are two main risks with Liquidity Provider Tokens: unsustainable loss and loss of opportunity. Closing your tokens in liquidity pools can result in other opportunities in the cryptocurrency market being closed to you. Furthermore, liquidity pools rely heavily on smart contracts, so any gap in their case can lead to the loss or theft of your tokens.

Summary

Today we have explained how LP tokens work and what distinguishes them. Undoubtedly, their importance in DeFi’s ecosystem will have a significant impact on its development. So, before you get interested in staking or yeld farming your LP tokens, you should carefully study the mechanisms and workings of the DeFi ecosystem.