LP tokens are not just a representation of one’s assets in DeFi, but they also hold significant value as a fundamental component of the decentralized exchange (DEX) and automated market maker (AMM) used by various decentralized applications (DApps). Liquidity providers earn passive income through transaction-generated fees earned by the liquidity pool in proportion to their investment share.
LP Tokens as Collateral for Crypto Loans
Aave and other cryptocurrency platforms allow liquidity providers to use their LP tokens as collateral to secure a crypto loan. Crypto lending has become a significant component of DeFi, enabling borrowers to use their crypto as collateral and lenders to earn interest from their borrowers. However, using LP tokens as collateral is still an emerging trend, and only a few platforms offer the service. It is highly risky, and borrowers may lose their assets if a certain collateral ratio is not maintained.
LP Tokens for Yield Farming and Compound Strategies
Investors can deposit their LP tokens in a yield farm or compounder to earn rewards. They can move their tokens manually using different protocols to receive LP tokens when they deposit them on another platform. Alternatively, they can use the liquidity pools of protocols like Aave or Yearn.finance, which help liquidity providers earn compounded interest more efficiently than humans. This system allows users to share expensive transaction fees and use different compound strategies according to the effort and time they want to dedicate to this type of investment.
LP Tokens for Staking
Liquidity providers can stake their LP tokens to earn extra profit. They transfer their LP assets to an LP staking pool in exchange for rewards of new tokens, incentivizing tokenholders to provide liquidity. Early stakers in a project can earn a high annual percentage yield (APY), which decreases as more LP tokens are staked in the pool. LP tokens function the same way as other tokens supported by a blockchain network, such as ERC-20 tokens issued on an Ethereum-based platform like Uniswap.
Overall, LP tokens hold significant value in DeFi beyond representing one’s assets. They can be used for collateral, yield farming, and staking, providing liquidity providers with various streams of revenue. However, it is crucial to note that these investment opportunities come with high risk, and investors should conduct thorough research before investing in LP tokens.