A liquidity provider (LP) supplies the assets or prices that other people trade against. The term has two meanings. In decentralized finance (DeFi), an LP is anyone who deposits a pair of tokens into a smart-contract pool and earns a share of the trading fees. In brokerage, a liquidity provider is a firm, such as a bank or a non-bank market maker, that supplies a broker with buy and sell prices and the volume behind them. If you put tokens into a pool, you are the liquidity provider. If you trade through a broker, the provider is a firm in the background.
The DeFi meaning: you deposit, the pool trades
How a pool works
Crypto firm Zerocap says liquidity providers "deposit pairs of tokens into smart contract-based liquidity pools" (Zerocap, 20 December 2024). In its example, an LP in an ETH/USDT pool supplies equal values of Ether (ETH) and Tether (USDT).
No order book matches buyers and sellers. An automated market maker (AMM) sets the price from the ratio of the two tokens in the pool. The Bank for International Settlements (BIS) describes the common design, a constant product function, in its December 2021 Quarterly Review as:
> Amount of token X * Amount of token Y = constant
A trader who buys token X takes X out of the pool and adds Y. X becomes scarcer in the pool, so its price rises.
What you receive
When you deposit, you get LP tokens that represent your share of the pool. Zerocap says these can be redeemed for your "initial stake plus any accrued fees." The token quantities you get back are usually different from what you put in, because traders have been swapping against the pool the whole time.
How DeFi LPs are paid
Traders pay a fee on every swap, and the fee goes to the pool's providers in proportion to their share. The BIS says the fee "may range from a few basis points to several percentage points," depending on the pool.
What a DeFi liquidity provider can lose
Impermanent loss
The BIS warns that when the relative price of the two tokens on other markets moves far from the pool's price, providers can end up worse off than if they had simply held the tokens. It adds: "The transaction fees may not be high enough to offset this loss, which is commonly referred to as 'impermanent loss'."
For a two-token constant product pool, Tiruviluamala, Port and Lewis (arXiv:2203.11352) give the formula:
IL = 2√t / (t + 1) − 1
Here t is the ratio of the final exchange rate between the two tokens to the initial one. IL is zero when the price does not change and negative (a loss against holding) in every other case. Worked from that formula, before fees:
| Relative price change of one token (t) | Pool value vs. simply holding |
|---|---|
| 1.5x | about −2.0% |
| 2x or 0.5x | about −5.7% |
| 4x or 0.25x | −20% |
The loss is called "impermanent" because it shrinks back if prices return to where they were when you deposited. If you withdraw while prices are apart, the loss is locked in.
Losses to arbitrage
A 2022 paper by Milionis, Moallemi, Roughgarden and Zhang (arXiv:2208.06046, last revised August 2026) separates an LP's return into two parts. One is exposure to market prices. The other is fees earned minus losses to arbitrageurs, who trade against stale pool prices. The authors call that second cost loss-versus-rebalancing (LVR). In the pool they studied, they found that market-price exposure explained over 99.991% of the variance in LP returns. In practice, the price moves of the tokens you deposit matter far more to your result than the fees.
Smart contract risk
Zerocap notes that because pools run on smart contracts, "any bugs or exploits can result in the loss of funds." No fee income protects a deposit from a flaw in the code.
Liquidity provider: DeFi pool depositor or broker-side supplier
Are you depositing tokens or trading through a broker? Read across each row for who the provider is, what it supplies, how it is paid and what it risks, as each publisher defines it.
| Provider, as defined by | Who it is or where prices come from | What it supplies | How it is paid | Risk named | Source |
|---|---|---|---|---|---|
| DeFi pool depositor (Zerocap) | Individuals or entities | A pair of tokens deposited in a smart contract pool | A portion of the pool's transaction fees | Impermanent loss, and bugs or exploits that can lose funds | Source: What are Liquidity Providers in Crypto (zerocap.com), accessed Oct 14, 2026 |
| Broker-side provider (Brokeree) | Banks, hedge funds, financial institutions or other brokers | Ample financial assets so traders can buy and sell with ease | Not in the quoted definition | Not in the quoted definition | Source: Liquidity Providers: the Engine behind Market Efficiency (brokeree.com), accessed Oct 14, 2026 |
| Broker-side provider (Leverate) | Not in the quoted definition | Buy and sell prices, plus the volume behind them, for a broker's clients | Not in the quoted definition | Not in the quoted definition | Source: What Is a Liquidity Provider? A Broker's Guide (leverate.com), accessed Oct 14, 2026 |
| Broker-side provider (X Open Hub) | A market broker or institution | Behaves as a market maker in a chosen asset class | The spread, or positions based on information available to it | Usually a significant amount of risk | Source: What Is a Liquidity Provider? Full Guide for Brokers | X Open Hub (xopenhub.pro), accessed Oct 14, 2026 |
| Broker-side provider (Luramic) | Prices may come from banks, non-bank market makers, electronic venues or other counterparties | Executable pricing and liquidity across financial instruments | Not in the quoted definition | Not in the quoted definition | Source: How to Choose a Liquidity Provider for Your Brokerage (luramic.com), accessed Oct 14, 2026 |
| Broker-side provider (Quadcode) | Usually reached via a bank, non-bank liquidity firm, prime-of-prime or aggregation setup | External market access: pricing and execution liquidity | Not in the quoted definition | Calls the market maker, not the provider, the risk-taking model | Source: Liquidity Provider vs Market Maker: What Brokers Misunderstand (quadcode.com), accessed Oct 14, 2026 |
Each row shows only the definition quoted from that publisher, so a cell marked not in the quoted definition does not mean the publisher's page is silent on the point.
In decentralized finance (DeFi) platforms, liquidity providers deposit pairs of tokens into smart contract-based liquidity pools.
The broker meaning: who supplies the prices
What the provider does
On the brokerage side, the definitions come from firms that sell liquidity or brokerage technology. Leverate says a liquidity provider "supplies the buy and sell prices, and the volume behind them." Brokeree lists "banks, hedge funds, financial institutions, or even other brokers" as possible providers. Quadcode (June 2026) says brokers usually reach this liquidity through a bank, a non-bank liquidity firm, a prime-of-prime or an aggregation setup.
Liquidity provider vs. market maker
The sources do not agree on this. X Open Hub defines a liquidity provider as a broker or institution that "behaves as a market maker in a chosen asset class." It says such a provider quotes both sides, can profit "from the spread or by positioning themselves," and usually takes on "a significant amount of risk." Quadcode separates the two: "a liquidity provider is a source of external market access; a market maker is a risk-taking model."
The difference connects to how a broker handles your order. In Quadcode's terms, under an A-book model, client trades are "hedged or routed externally, usually through LP relationships." Under a B-book model, they are "internalized, so the broker carries the opposite exposure." A hybrid model mixes the two.
Which meaning applies to you
| DeFi pool LP | Broker-side LP | |
|---|---|---|
| Who it is | Anyone who deposits tokens, including you | Banks, non-bank firms, other brokers |
| What it supplies | A token pair locked in a smart contract | Buy and sell prices and the volume behind them |
| How it is paid | A share of swap fees | The spread, or its own positions (X Open Hub) |
| Main risks | Impermanent loss, arbitrage losses (LVR), contract bugs | Market risk on its positions (X Open Hub) |
If you are thinking about depositing into a pool, the fee rate on its own tells you little. Compare it with how far the two tokens could move against each other. A pair of two stablecoins moves little relative to each other. A volatile token paired with a stablecoin can move a lot. For another way to earn on crypto holdings, see our explainer [comparing staking and yield farming](/blog/staking-vs-yield-farming-hands-off-network-security-or-active-riskier-defi-yield/).
Limitations: the broker-side definitions come from vendors that sell liquidity or brokerage technology, and most of their pages are undated.
