Currently, there is over $41 billion Total Value Locked on DeFi protocols. Decentralized exchanges and lending protocols accumulate the lion’s share of this TVL. However, as DeFi stands, unique possibilities exploiting the convergence of these two dominant markets are still to be leveraged.
Liquidity providers (LPs) in Automated Market Maker (AMM) models like Uniswap and SushiSwap receive in their wallets ‘pool shares’, or LP tokens, in exchange for the tokens they deposit in the pools. Liquidity tokens represent a fractional stake in a liquidity pool. LP tokens can be staked for earning rewards through yield farming or leveraged to take out crypto loans.
To effectively represent someone’s share of the pool and allow it to be freely exchanged, LP tokens are the best option due to the dynamic nature of the token pair, which changes proportionally whenever a transaction is made. When someone cashes in their pool balance, the same number of liquidity tokens are burned.
In certain digital asset exchanges (DEXs), LP tokens are regular ERC-20 tokens. Some DEXs employ NFTs as liquidity provider tokens, including the widely used Uniswap v3 and its clones. However, composability issues may still be addressed by encasing non-fungible liquidity tokens into ERC-20 tokens.
In all of DeFi, LP tokens may be traded, purchased, and used just like any other currency. However, there are currently only a small handful of viable options for deploying LP tokens into the DeFi ecosystem.
The True Value of LP Tokens in a DeFi Ecosystem
The key value of LP tokens lies in their composability. Within crypto, composability is the ability of decentralized applications (dApps) and DAOs to integrate the features of one another. Most traders nowadays use liquidity mining as their primary strategy for making use of LP tokens’ composability capabilities.
Liquidity mining, to put it simply, is the practice of incentivizing participants to add to a given pool of liquidity by providing incentives to those who do so. Programs designed for liquidity mining provide a user interface for staking LP tokens in exchange for incentives.
DeFi lending platforms leveraging liquidity mining programs can use LP tokens for their project’s governance, and enable the fixed-interest markets to function well. Leveraging…
