Becoming an LP on DEX: Why Does It Keep Making You Poorer?

Did you know how many DEXs exist in crypto today?

The answer is over 1,700 — far more than any other DeFi category.

And what’s the total TVL of DEXs now? Around $2.3 billion. In comparison, lending protocols currently hold over $7.1 billion in TVL. Four years ago, DEXs peaked near $8 billion in TVL, while lending protocols had less than $5 billion.

Clearly, being a DEX LP is no longer a “sure-win” strategy.

You deposit two assets and provide liquidity for months, only to realize you’d have been better off just holding. The fees you earned are minimal, and impermanent loss (IL) just keeps stacking up. And don’t even mention Uniswap V3 — its active range setting is a high-level task most retail users can’t handle.

You thought being an LP was about combining assets to earn trading fees — a seemingly safe, passive income. But once you understand the math and economics behind it, you may be shocked by the hidden costs of providing liquidity. This article dives into the heart of it.

Being an LP Is Always a Tradeoff Between Risk and Return

Providing liquidity isn’t a guaranteed way to make money. It’s essentially a permissionless collaboration: you put up assets, help facilitate trading, and in return, you earn certain rewards — but not without risk. While these are generally labeled as “rewards,” they actually come in various structures.

So, what kinds of returns are we talking about? Broadly speaking, they fall into a few main categories:

Trading fees

This is the most fundamental form of LP income, distributed proportionally among all liquidity providers in a pool based on trading volume. Every swap that goes through your pool contributes to this revenue.

Protocol token incentives

Protocols often boost pool yields by distributing governance tokens. Through carefully designed emission curves or supply controls, they can artificially inflate returns to attract capital.

Governance-based rewards and bribes

A more advanced layer of incentives can be seen in protocols like Curve and Velodrome, where veToken holders vote to direct emissions toward specific pools. As an LP, you can earn additional rewards by locking tokens and participating in this vote-directed flow of incentives.

But what about the risks?

Importantly, unless both assets in the LP are stablecoins, you’re inherently exposed to price risk. As market prices shift, your LP position rebalances accordingly, leading to changes in its overall value.

It helps to think intuitively here: when you LP, you’re essentially market making. The take is — you’re doing it passively, which means your losses often come at the hands of more active players in the market.

With So Many Rewards, Why Don’t LPs Make Money?

The core reason behind LP underperformance is the market itself. Take a simple example: when ETH’s price drops, your LP position is effectively “buying the dip” — which sounds fine, until you realize it’s buying all the way down. As the value of your position depreciates, the supposed high APR becomes meaningless. Trading fees are uncertain; volatility is not. This is the origin of impermanent loss (IL).

Impermanent loss is an inevitable cost for anyone providing liquidity on a DEX. It may sound abstract, so let’s use an example to illustrate how it works.

1. Initial state

Using the classic AMM formula x * y = k, suppose 1 ETH = 100 USDT. A user deposits 1 ETH and 100 USDT into the pool. The pool’s total size is 10 ETH and 1,000 USDT(total pool value: $2,000), meaning the user owns 10% of the pool.

2. Price change

ETH rises to 200 USDT. To maintain k constant, the pool rebalances by reducing ETH and increasing USDT. The pool now holds approximately 7.071 ETH and 1414.2 USDT. The total value is $2,828. Your 10% share is now worth about $282.8.

3. If you just held

If you held 1 ETH and 100 USDT instead of LPing, your portfolio would now be worth $300.

4. Impermanent loss

The IL here is 300 - 282.8 = 17.2 USDT. You didn’t lose money in absolute terms — your position grew from $200 to $282.8 — but you made less than you would have if you just held. That's an opportunity cost.

So why call it “impermanent”? Because, if ETH returns to 100 USDT and you haven’t withdrawn yet, the loss disappears. IL only becomes realized when you withdraw at a price diverged from your entry.

But IL isn’t the only problem. Even if prices return to the starting point, LPs can still lose out. Why? Because there are always sharper, faster players in the market. These active participants profit from volatility regardless of direction, whereas LPs — being passive — do not. This brings us to another core cost: Loss Versus Rebalancing (LVR).

LVR is another key concept researchers use to assess LP cost. Let’s build on the IL example above to demonstrate how it works.

1. Initial state

As before, the user adds 1 ETH + 100 USDT into a DEX LP at 1 ETH = 100 USDT.

2. Price moves up and back down

ETH rises to 200 USDT, then falls back to 100. The pool rebalances throughout. In theory, the pool looks like it’s returned to its starting state. But not for you.

3. Rebalancing path comparison

After ETH hits 200 USDT, your LP position holds ~0.71 ETH and 141.5 USDT — meaning you sold ~0.29 ETH for 141.5 USDT total. But a rebalancing strategy that actively sells 0.29 ETH at 200 USDT would earn 58 USDT. So you’ve lost 16.5 USDT relative to the optimal rebalance.

On the way back down: As ETH falls to 100, the LP effectively repurchases 0.29 ETH for 41.5 USDT. A smart rebalancer would buy the same 0.29 ETH at just 29 USDT. That’s another 12.5 USDT lost.

4. Total LVR

16.5 + 12.5 = 29 USDT. This is the loss from not actively managing your position like a rebalancer — and instead relying on the DEX’s passive AMM mechanics.

This illustrates that an arbitrageur, starting from the same position as an LP, can capture additional value simply by reacting faster to price changes between CEX and DEX. By continuously monitoring price movements and executing cross-venue trades, they are able to extract profit from the LP’s passive pricing exposure — even if market prices ultimately return to their original level.

How to LP Smartly

Now that we understand DEX LPing isn’t a “deposit-and-earn” model but rather a dynamic risk arena and a strategic composition game, the next question becomes clear: how do you become one of the few LPs who don’t lose money — or even turn a profit?

Position Management

Modern DEX AMM designs have become increasingly sophisticated, but at a high level, they can still be categorized into two types: concentrated liquidity and non-concentrated liquidity. If you’re familiar with Uniswap, this roughly corresponds to the difference between V2 and V3.

In concentrated liquidity models, you can deploy your funds within a specific price range. This can result in extremely high displayed APRs — but it also amplifies impermanent loss within that range.

And once the price drifts too far outside your selected range, your liquidity effectively becomes idle — “just lying in the pool doing nothing,” generating no trading fees. That’s why choosing the right range is crucial for optimizing actual returns.

For example, in Aerodrome’s WETH–USDC pool, different LP ranges produce wildly different APRs — from 300% down to 58%. This clearly illustrates how APR is highly sensitive to price volatility and range selection.

Reward Structure

This is something we’ve already highlighted when discussing APR and APY. Whether it’s a lending or DEX protocol, understanding the mechanics behind yield — where the rewards come from and how they’re sustained — helps you make more rational LP decisions. High numbers often mask unsustainable incentives.

Asset Quality

Price volatility isn’t always driven by normal market dynamics — sometimes it stems from problems with the asset itself.

Take a USDT–USDC LP pair as an example. If USDT depegs due to a black swan event, traders will rush to dump their depreciating USDT into your pool, draining your valuable USDC. Arbitrageurs leave with profits; you, the LP, are left holding the bag.

Mindset Shift

LPing on a DEX doesn’t always have to mean traditional market making. For example, memecoins often experience surging trading volume shortly after launch. If you believe a certain memecoin has already peaked in price but still sees high volume, it might be smart to LP — not just for exposure, but to earn fees that offset the volatility risk.

Protocols like Meteora on Solana even allow single-sided LPing. In a SOL–USDC pool, for instance, you can choose to deposit only SOL. This setup essentially functions like a limit order, offering more flexible LP strategies tailored to active trading intentions.

End

For newcomers, being a DEX LP is undeniably a tough business. The mechanisms are complex, returns are volatile, and you face multiple layers of risk — from slippage to impermanent loss to MEV extraction. It’s far from the simple “deposit and earn” model many imagine.

But precisely because it’s hard, LPing has never been treated as a “final form.” Instead, it’s become one of the most actively evolving areas in DeFi infrastructure.

Today, we’re seeing more and more projects tackling these structural pain points head-on:

Some combine LP with lending, allowing positions to earn both fees and interest to improve capital efficiency; Some design MEV-resistant AMMs that shield LPs from sandwich attacks and value extraction; Others explore automated impermanent loss hedging through structured strategies that protect LPs from price volatility.

These solutions may still be in their early stages, but they all point to the same conclusion:

DEX LPing is still evolving.

Disclaimer: This content is for educational purposes only and does not constitute financial advice. DeFi protocols carry significant market and technical risks. Token prices and yields are highly volatile, and participating in DeFi may result in the loss of all invested capital. Always do your own research, understand the legal requirements in your jurisdiction, and evaluate risks carefully before getting involved.