What are LP tokens?

LP tokens are tokens that a decentralized exchange issues to people who add funds to a liquidity pool. They work like a receipt. Whoever holds them can claim a matching share of the pool, so they need the same care as the funds they stand for.

What is LP token in crypto?

Uniswap's version 2 documentation describes the basic process. When someone deposits a pair of tokens into a pool, the pool's smart contract mints liquidity tokens and sends them to the depositor. The amount is proportional to that person's share of the pool. For a brand-new pool, the first deposit receives an amount equal to the square root of the two deposited amounts multiplied together.

To leave, the provider sends the LP tokens back and the contract burns them. In exchange, the provider receives their portion of each token in the pool. Uniswap notes that LP tokens are themselves tradable, so they can be transferred or sold like other tokens. Whoever ends up holding them owns the claim on the pool.

What do LP tokens represent?

An LP token represents a percentage of the pool, not a fixed number of coins. On Uniswap v2, each trade pays a 0.3% fee that is added to the pool and shared pro rata among providers. As fees build up, each LP token is backed by slightly more.

The mix of coins behind each token also changes as traders swap. When the provider withdraws, they may get back more of one token and less of the other than they deposited. The result compared with simply holding the coins is called impermanent loss.

Are all liquidity provider tokens the same?

No. Older pool designs issue fungible LP tokens, where every unit is identical. Uniswap v3 lets providers concentrate funds within a chosen price range, so each position is different. Its documentation treats each position as an ERC-721 token, a type of NFT with its own ID that records the token pair and amount of liquidity.

Because LP tokens carry a claim on real funds, losing them, or approving a malicious contract to move them, can mean losing the deposit.

Are LP tokens taxable?

It depends on the country, and rules are still forming. In the UK, HMRC published a policy paper on July 13, 2026 for liquidity pools that use automated market making. From April 6, 2027, entering a pool and later leaving it are to be treated as no gain, no loss, up to the quantity of each token originally deposited. Any extra or shortfall in tokens received on exit gives rise to a gain or loss. See how crypto is taxed in the UK for the wider rules.

In the US, the IRS has not issued guidance specifically on providing liquidity, according to tax software firm CoinLedger. Some tax professionals treat swapping coins for LP tokens as a taxable crypto-to-crypto trade, while others treat it as a non-taxable deposit.

Rules differ by country and change often. Check the tax authority or a qualified professional for your own situation.