Becoming an LP: how to think before adding liquidity
Providing liquidity is closer to market making than earning interest.
What drives results
- Fees (volume-dependent)
- Price movement
- Range choice (v3)
How to choose a pool
- Liquidity depth and volume.
- Would you hold both assets?
- Volatility and IL risk.
- Fee tier selection (v3).
Fees are not the whole story
Fee income can be real, but price movement can dominate your outcome. Evaluate LP results as part of your total portfolio, not as a separate “yield product.”
Beginner LP checklist
- Would I hold both tokens for months?
- Is the pair liquid and actively traded?
- Do I understand impermanent loss for this volatility?
- In v3: am I willing to manage ranges?
How to evaluate LP results
Look at your position as a combined portfolio, not two separate tokens. Compare your outcome to a simple “hold both tokens” baseline. Fees can improve the outcome, but large price moves can dominate the final result.
What to track
- Entry prices and range (for v3)
- Fees earned over time
- How often you rebalance and the gas cost of maintenance
A common beginner mistake
Choosing a pool only because an APR screenshot looked high. High APR often reflects short bursts of volume or temporary incentives, not stable long-term returns.
v2 vs v3: choosing your complexity
v2-style liquidity is simpler: deposit two tokens and your liquidity is always active. v3 can be more efficient but requires decisions about ranges and fee tiers. If you don’t want active management, choose wider ranges or strategies designed for low maintenance.
Operational risks
- Gas costs from minting, adjusting, and collecting fees.
- Human error: wrong range, wrong fee tier, or misunderstanding what “out of range” means.
- Market regimes: trends can punish certain LP strategies.