What is a Liquidity Pool Token? Discover this type of token

An LP token or liquidity pool token is a type of token created and issued by DEX (Decentralized Exchange) platforms. This type of token consists of the following: Liquidity providers use their tokens to inject liquidity into some liquidity pools within DEXs, and as a result, these liquidity providers receive a reward equivalent to the injection of liquidity they have provided to the liquidity pool using the liquidity pool token as a form of payment.

This type of token and its method is widely used by some relevant decentralized exchanges such as Uniswap, Sushiswap or Pancakeswap, in the latter you can find Reental's liquidity pools. Thanks to this, you can buy or sell tokens without the need for another party to be interested in them. From any side, at any time and without the need for a counterpart, let's go, all advantages.

How do liquidity pool tokens work?

Each token of this type may vary depending on the project that is managing it, so to explain how it works, we are going to rely on the Uniswap DEX (UNI) token, which many of you will know, to make it easier for you to understand this new concept. The token is an ERC-20 utility, which as many of you know works on the Ethereum blockchain and whose smart contract you can find here.

With the information that can be seen in the image, we are already clear that UNI is a fungible, transferable token for free use within the Ethereum network. The image also informs us that its issuance is limited, so the value of the token will appreciate over time and with use, a very important aspect to take into account due to the total liquidity provided within the DEX liquidity pools.

Let's see below what the formula for calculating the value of a token in a liquidity pool looks like:

LP Token Value = Total Value of the Liquidity Fund/Circulating Supply of LP Tokens

If we continue with the example of the UNI token, perhaps we can understand this concept more easily. It is known that Uniswap has a TVL of 7.87 billion US dollars, the resulting total is divided by the liquidity locked in its V2:

And the locked liquidity in your V3:

In addition, we can take into account that there are currently a total of 627,286,736.56 UNI in circulation, so we can apply the data to the formula and thus be aware of the value of your LP token.

UNI Value = $7.87 billion/627,286,736.56

UNI Value = $12.84

You may be wondering why the resulting value of the formula is different from what can be seen on CoinMarketCap? This is because the result of the formula is the value granted by the token using the data provided by Uniswap. Therefore, the formula does not take into account other secondary markets or exchanges where the token is present. Therefore, if we want to know with maximum accuracy the price of the token, we must take into account the liquidity of UNI in these spaces and add them together, which will give us a much more accurate result.

What about the other LP Tokens?

Now that we have made it clear how the UNI case works, we can extrapolate its rules to the other liquidity pool tokens, so what we have learned works for the other tokens 😉.

• Each liquidity pool token works under a single blockchain and standard.
• The value of liquidity pool tokens depends on the total value of the platforms on which they are present, whether CEX or DEX.
• As with most tokens, a burning of LP tokens will have a positive influence on the value of that token.

It is also important to keep in mind that each platform (DEX) has different issuance rules from the others, so these can affect, to a greater or lesser extent, the value of the token. Therefore, it will be necessary for us to know the structure and operation of the project that issued the token, if we do it right we will be aware of the increase in value of the token and how far it can go.

Conclusion

Liquidity pool tokens can be very interesting for us to adopt new products, especially those related to DeFi (Decentralized Finance). However, taking into account the usefulness and possibilities of this type of tokens, LP tokens are being used on various metaverse or P2E platforms, all with the purpose of attracting people to these platforms and thus increasing their adoption.

Finally, the success of the liquidity pool token will depend on the product it represents, the interest it manages to awaken in users and its usefulness.

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Welcome to the new way of doing finance, welcome to Reental.