Liquidity Provision
Web3 / defi
The act of depositing assets into a liquidity pool or market-making protocol to enable trading, lending, or borrowing for other users, in exchange for earning fees or yield. In AMM-based DEXes like Uniswap, liquidity providers (LPs) deposit equal value of two tokens into a pool, and the protocol uses these reserves to execute trades automatically using a pricing algorithm. LPs earn a share of trading fees proportional to their pool share, but also face impermanent loss—the risk that the relative price change of the two deposited assets causes their pool position to be worth less than simply holding the tokens. Liquidity provision in lending protocols (Aave, Compound) involves depositing single assets that are lent to borrowers, earning interest rates that fluctuate with utilization. Example: An LP depositing $10,000 of ETH and $10,000 of USDC into Uniswap v3 earns 0.3% of every swap that uses their liquidity range, but must actively manage their price range to ensure their liquidity stays in-range as ETH price moves. Why it matters for Web3: Liquidity provision is the mechanism that makes DeFi function—without LPs willing to deposit assets and absorb price risk, there would be no trading, no lending, and no price discovery in decentralized markets. LP incentive design is central to protocol economics.
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