By the end you will know what an LP actually sells, why impermanent loss is the worst named idea in DeFi, and when the house wins and when it quietly becomes exit liquidity.
You have walked past this booth in every airport on earth. Two trays of currency, a posted rate, a small fee on every exchange. Someone stocked both trays, and that someone earns the fee all day long.
Last checkpoint you met the pot: two tokens, one formula, arbitrageurs keeping the price honest. Somebody filled that pot. This lesson you step behind the counter and learn the business of being the house.
The pot from the AMM lesson is crowdsourced. Deposit both tokens, in the pool's current ratio, and you own a share of the booth. From that moment, every swap anyone makes pays you a fee, sliced in proportion to your share.
Pools publish a fee tier when they are created; different pairs run different tiers. No application, no shift schedule, no manager. You stocked the trays, so you are the house.
What does the booth actually sell? Not tokens: convenience and immediacy. A trader wants to swap right now, and you are already standing there, stocked on both sides, always the counterparty to their trade.
So, who is paying? Traders are. Every swap, the fee at the door, straight into your share. Hold that comfort loosely. Before we open the catch, place a bet on what the price does to your stock.
Here is the mechanism, before its name. When ETH rises elsewhere, your pool's price is briefly stale, and the arbitrageurs from last checkpoint arrive to correct it. They buy your cheap ETH until the ratio matches the world. The rebalance happens through you.
Your booth ends up holding more of whatever fell and less of whatever rose. Travelers dump the falling currency; the booth dutifully buys it. That is what LPs quietly pay arbitrageurs whenever the world moves. Push the price yourself and watch the till.
Draw the business on the board. The dashed line is a person who simply held the two tokens. The solid curve is your LP stake. They touch on deposit day, and then any big move, in either direction, opens a gap between them.
The gap is not a fee, and nobody took it from a drawer. It is the rebalance you just ran, added up: the booth kept selling winners and buying losers, so the curve trails the line. Tap the three points to read it.
The gap you just read has a name, and the name arrives last because the name misleads. It is called impermanent loss. Impermanent: true only if the price walks all the way back to where you deposited. Nothing forces it to.
Loss lies too. It is a comparison against a person who simply held, not money missing from the till. Your stake can grow while the gap grows. You can be up, and still trail the holder.
Now the honest ledger of the business: LP profit equals fees earned minus that gap. Two columns, always both. A stable pair booth sees tiny moves: nearly no gap, and thin fees to match. A volatile pair swings hard: fat fees, fat gap.
There is no free lane; there is a price for every lane. Two friends are about to test you on exactly this.
One scenario deserves its own board. Stock a booth for a token that goes to zero, and the machine does exactly what you watched: it buys the falling token at every price, all the way down. Your USDC leaves; the dead token piles up.
The crowd selling it on the way down needed a buyer, and the buyer was you. The market has a polite name for that seat: exit liquidity. The house always trades. It does not always win.
Zoom out and pin the business to your map. The pot from last checkpoint gains an owner: the LP, paid in fees by traders, quietly rebalanced by arbitrage, carrying the gap against just holding. One booth, two columns.
One test before you close the till. A friend has heard about the gap and reached a conclusion. Find where their lens breaks.
You know the business now. The booth sells immediacy, traders pay the fee at the door, arbitrage rebalances the trays through you, and the gap against just holding is the cost that fee income must beat. Two columns, every pair, no free lane.
Then Uniswap v3 asked a strange question: what if the booth could choose where on the curve to stand? Next: concentrated liquidity, where LPing became a job.