LP tokens are sent to liquidity providers after adding liquidity to Terraswap pools — MIR-UST and/or mAsset-UST and burned when the provider removes their share from the pool. They’re mostly used for accounting, representing the provider’s share in the pool for return of assets when they remove their liquidity. Every pool has a unique LP token that cannot be combined with LP tokens from other pools.
LP tokens can be sent to stake. This process is rewarded with MIR.
Rewards for LP holders
LP holders are those who have provided liquidity and received them according to their share in the pool. They receive rewards from fees within the network for user trades inside the pool. An exchange inside a pool comes with a 0.3% fee, which is then distributed between LP token holders proportionally to their share in the pool. Since rewards for trading fees return to the pool, they can only be withdrawn by burning LP tokens and removing liquidity.
LP staker rewards
LP stakers are those who have sent their LP tokens to stake. It’s necessary so that more liquidity can be added to the pool and removed from it less often. The more liquidity, the more stable the price of the asset. LP staking is encouraged with a generous reward in MIR.
A certain amount of MIR is minted on the creation of every block, these MIR are distributed between all LP stakers proportionally to their share in the stake.
The rewards for staking the LP token of MIR-UST is 3 times higher than that of staking the LP tokens of mAsset-UST pools.
Burning LP tokens
LP tokens are burned when you want to remove liquidity from a pool and return your MIR and UST. It is most likely that the correlation of the returning tokens will be different from what you provided. It involves a lot of factors: the exchange rate compared to UST, change of your relative personal share in the liquidity pool, and the so-called impermanent loss.
What is Impermanent Loss?
Impermanent loss — partial loss of profit
1 MIR = 100 UST
Peter provided liquidity to the pool: 1 MIR and 100 UST. There’s a total of 10 MIR and 1 000 UST in the pool. That means Pete’'s share is 10%.
In some time, users, completing trades during which they added UST to the pool but removed MIR from it, made the price or MIR rise to 400 UST. Now there’s 5 MIR and 2 000 UST in the pool.
Peter decided to take back his share from the pool. Since his share was 10%, he extracted 0.5 MIR and 200 UST. Translated into dollars, Peter should have $400 now, right? (0.5 MIR x 400 UST + 200 UST).
But if Peter didn’t provide liquidity to the pool, and held the tokens instead (1 MIR and 100 UST), he would have $500 now (1 MIR x 400 UST + 100 UST). There’s a $100 difference, this is called impermanent loss.
Below are some examples of impermanent loss on price fluctuation:
- 25% change (1.25x) = 0.6% loss
- 50% change (1.5x) = 2%
- 75% change (1.75x) = 3.8%
- 100% change (2x) = 5.7%
- 200% change (3x) = 13.4%
- 300% change (4x) = 20%
- 400% change (5x) = 25.5%
Always keep this factor in mind when you’re accounting for the profitability of providing. This loss can be compensated with fees that the provider receives for providing liquidity, as well as LP staking and the MIR rewards for it.
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