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What is a LP token?

A Liquidity Proving (LP) token is the token that a liquidity provider receives in exchange for the amount contributed. This token serves as proof of deposit.

The value of an LP token corresponds to the total value of the assets contained in the pool at a given time, divided by the overall quantity of LP tokens at that time.

The value of the LP token may vary depending on:

  • Fees generated by exchanges via the liquidity provided by the pool;

  • Fluctuations in the value of the assets constituting the pool.

When a liquidity provider decides to withdraw its liquidity, the LP token enables it to do so in proportion to the value of this LP token.

As an example:

Paul deposits 500 USDT and 500 USDC in a liquidity pool consisting of 49,500 USDT and 49,500 USDC.

Upon deposit, 1 USDT = $1 and 1 USDC = $1.

His deposit in the pool is worth $1,000. Paul receives 1,000 LP.

For several weeks, users trade using the funds contained in the pool. These trades generate fees that remunerate the pool and increase its value.

Paul decides to withdraw his liquidity. At this point, the pool is made up of 50,200 USDT and 49,900 USDC. This equates to 100,000 LP tokens, divided between the various liquidity providers in proportion to the share of liquidity they have contributed.

Upon withdrawal, 1 USDT = $0.997 and 1 USDC = $1.003.

Hence, Paul's 1,000 LP represent 502 USDT and 499 USDC, that is to say $1,001.

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