To determine the share of a liquidity provider in a pool, platforms generate a new token for the pair. This token is known as a liquidity pool token or LP token. They generate in accordance with the pair and share of the pool.
For example, if a trader contributes $40 worth of KMD and USDT to a Binance smart chain pool with a total value of $200. They will receive 20% of that pool’s LP tokens. This means that they own 10% of the crypto liquidity pool. On most platforms, the name of LP tokens varies with the trading pairs.
In the example above the LP token for the trading pair is KMDTUSDT. The number of tokens varies on the price difference for a said pair. For example, 1 KMD and 3 USDT will make 1 KMDUSDT token. The same goes for every asset you provide in the liquidity pool.
The purpose of LP tokens is to ensure there is no custody of your funds in a liquidity pool. They are the key function of an automated market maker in a liquidity pool. To ensure that a pool is really automatic, decentralized, and fair, LP tokens come into play.
The non-custodial feature of AMM platforms is key to being part of the decentralized finance ecosystem. You remain in control of your assets by receiving LP tokens in return for providing liquidity to the pool. This ensures a fair play providing you with something of value for providing the pool something of value.
These LP tokens also ensure network security. This means they are highly lucrative and crucial for a liquidity provider or platform. The more the coins stay inside the same ecosystem, the more secure, stable, and scalable the network becomes. To achieve this DEFI has introduced users with more incentives such as yield farming,
The Liquidity pool tokens generated are ERC-20 standard. This means they are a token like Ethereum or Binance smart chain tokens. Traders can also trade LP tokens outside their platform of origin. This means stakeholders can use them for further operations.