Providing liquidity in decentralized finance (DeFi) isn’t just a technical term-it’s a way to earn passive income just by holding crypto. You don’t need to trade, speculate, or time the market. You simply deposit two tokens into a smart contract, and in return, you get a share of every trade that happens in that pool. It sounds simple, but there are real risks and smart strategies behind it. If you’ve heard about earning 20%, 40%, or even 70% APY from liquidity pools, this is how it actually works-and what you’re really signing up for.
What Is a Liquidity Pool?
A liquidity pool is a smart contract that holds pairs of cryptocurrencies, like ETH and USDC, or SOL and USDT. These pools replace traditional order books used by exchanges like Binance or Coinbase. Instead of matching buyers and sellers directly, trades happen against the pool. If you want to swap 1 ETH for USDC, the pool gives you USDC from its reserves and takes your ETH. The price is set automatically by a mathematical formula, not by a human trader.
This system is called an Automated Market Maker (AMM). Uniswap, launched in 2018, made it popular. Today, pools on Uniswap, SushiSwap, Curve, and Raydium handle billions in daily trades. When you add your tokens to one of these pools, you become a liquidity provider (LP). In return, you get LP tokens-digital receipts that prove you own a slice of that pool.
How Do You Earn Fees?
Every time someone swaps tokens in a pool, they pay a small fee-usually 0.3% on Uniswap, 0.04% on Curve for stablecoins, or 0.2% on Solana-based Raydium. That fee doesn’t go to the platform. It gets split among all the liquidity providers in that pool. So if you own 1% of the ETH/USDC pool, you earn 1% of every fee generated by trades in that pool.
Let’s say the ETH/USDC pool has $10 million in total value and trades $100 million in a week. At 0.3% fees, that’s $300,000 in fees. If you’ve put in $10,000 worth of ETH and USDC, you own 0.1% of the pool. That means you earn $300 in fees that week. That’s $15,600 a year, or 156% APY-before any extra rewards.
But here’s the catch: not all pools are equal. Pools with high trading volume, like ETH/USDT or BTC/USDC, earn more fees. Pools with low volume, like some obscure altcoin pairs, might earn pennies. And some platforms give you extra tokens on top-UNI from Uniswap, CRV from Curve, or SUSHI from SushiSwap. These can add 10-30% more to your yield.
Impermanent Loss: The Hidden Risk
Here’s where most people get burned. Let’s say you deposit $1,000 worth of ETH and $1,000 worth of USDC into a pool. The price of ETH is $3,000 per coin. A week later, ETH jumps to $6,000. The pool automatically rebalances to keep the ratio of ETH to USDC stable, so it sells some ETH and buys USDC to match the new market price.
When you withdraw, you get back less ETH than you put in-and more USDC. Even though ETH doubled, your total value might only be $1,800 instead of $2,000 (what you’d have if you just held the tokens). That $200 gap? That’s impermanent loss.
It’s called "impermanent" because if ETH drops back to $3,000, the loss disappears. But if you withdraw while the price is off, it becomes real. The math is brutal: if one token doubles, you lose about 5.7% compared to just holding. If it triples, you lose over 13%.
That’s why experienced providers stick to:
- Stablecoin pairs (USDC/USDT, DAI/USDC)-low volatility means near-zero impermanent loss.
- Correlated assets (ETH/wstETH, BTC/renBTC)-they move together, so price ratios stay close.
- High-fee pools with strong volume-fees often cover the loss over time.
Never provide liquidity to a token pair with wild swings unless you’re ready to absorb losses. A 200% APY pool with a 30% impermanent loss isn’t a win.
Where to Provide Liquidity
Not all platforms are created equal. Here’s what’s actually working in early 2026:
- Uniswap V3 (Ethereum, Arbitrum, Polygon): The largest pool provider. V3 lets you choose a price range for your liquidity-concentrating it where trades happen. This boosts fee earnings but needs active monitoring. Great if you know the price range.
- Curve Finance (Ethereum, Polygon): Best for stablecoins. Fees are low (0.04%), but impermanent loss is almost zero. They also pay CRV rewards, pushing yields to 5-15% APY.
- Raydium (Solana): Low fees, near-zero gas costs. Perfect for small deposits. Solana’s speed makes rebalancing easy. Yields hover around 8-12% from fees alone, plus SOL rewards.
- Balancer (Ethereum): Lets you create pools with up to 8 tokens and custom weights. Good for advanced users who want fine control.
Most users start on Uniswap or Raydium. Ethereum is still the most liquid, but Solana is catching up fast-especially for deposits under $1,000.
How to Get Started
Here’s the step-by-step process, no tech background needed:
- Connect your wallet (MetaMask for Ethereum, Phantom for Solana).
- Choose a pool based on your risk: stablecoin pairs for safety, ETH/USDC for balance, or volatile pairs only if you understand the risk.
- Deposit equal value of both tokens. The platform calculates this for you. If you have $500 in ETH, you need $500 in USDC.
- Approve the transaction in your wallet. This costs a few dollars on Ethereum, less than $0.50 on Solana or Polygon.
- Confirm the deposit. You’ll get LP tokens in your wallet.
- Track your position on the platform’s dashboard. Watch fees accumulate and check for impermanent loss.
Most platforms require a minimum of $100-$500 to make sense. Smaller deposits get eaten up by gas fees. On Ethereum, a $50 deposit might cost $10 in gas to enter and exit. On Solana? You can do it for $0.20.
Advanced Tips: Boosting Your Returns
If you’re serious about earning more, here’s what pros do:
- Yield farming LP tokens: Stake your LP tokens on another protocol. For example, deposit your UNI-V3 LP tokens into a staking pool that pays extra UNI. This can double your yield-but adds more risk. If the token price drops, you lose twice.
- Use automated tools: Platforms like Yearn Finance or Beefy Finance auto-compound rewards and shift your liquidity to the best-paying pools. You don’t need to monitor it daily.
- Rebalance manually: If one asset grows too much, withdraw, sell the excess, and re-deposit equal values. This reduces impermanent loss but costs gas.
- Track APY dashboards: Use DeFiLlama or APY.vision to compare pools in real time. Fees change daily. A pool at 15% today might be at 5% next week.
One user on Reddit posted a 3-month log: they started with $2,000 in ETH/USDC on Uniswap V3. Fees earned: $410. Impermanent loss: $180. Net gain: $230 (11.5% over 3 months). Not flashy, but steady. They didn’t touch it.
What’s New in 2026
DeFi is evolving fast. In early 2026:
- Layer 2 dominance: Over 70% of new liquidity now flows to Arbitrum, Polygon, or Base. Ethereum mainnet is too expensive for small providers.
- Regulatory pressure: The EU’s MiCA regulation now requires KYC for DeFi users who lock over €10,000 in liquidity. This is slowing institutional entry-but not stopping it.
- Cross-chain pools: Protocols like Synapse and Stargate let you provide liquidity across chains. You deposit on Solana, earn fees on Ethereum. Riskier, but higher rewards.
- AI-powered LP tools: New bots now predict price trends and auto-adjust concentrated liquidity ranges. They’re still experimental, but some users report 30% higher fee earnings.
The big takeaway? Liquidity provision isn’t "set and forget." It’s more like a part-time job. You need to watch your pools, understand the risks, and adjust. But if you do it right, it’s one of the few ways to earn real returns from crypto without selling your assets.
Can you lose money providing liquidity?
Yes. You can lose money from impermanent loss if the price of one token moves sharply compared to the other. You can also lose if the platform gets hacked, or if the token you’re earning as a reward crashes. Always start small, stick to well-known pools, and never put in more than you can afford to lose.
Is liquidity provision better than staking?
It depends. Staking gives you fixed, predictable returns-like 5-8% on Ethereum. Liquidity provision can earn 10-50% or more, but comes with risk. If you want safety, stake. If you want higher returns and can handle price swings, provide liquidity. Many users do both: stake some, provide liquidity with the rest.
Do I need to pay taxes on liquidity pool earnings?
In most countries, yes. The fees you earn are treated as income. When you withdraw, the value of your LP tokens at that moment is taxable. Some places tax the swap when you deposit tokens, others tax when you withdraw. Keep records of every deposit, withdrawal, and token price. Tax software like Koinly or TokenTax can help track it.
Why do some pools pay more than others?
High fees come from high trading volume. Pools like ETH/USDT have millions in daily trades, so fees add up. Low-volume pools earn little. Also, platforms offer extra rewards (like UNI or CRV tokens) to attract liquidity. These are temporary incentives-once they end, yields often drop. Always check if rewards are still active.
Can I withdraw my liquidity anytime?
Yes, you can withdraw anytime. But if you do it when one token has moved a lot in price, you’ll likely experience impermanent loss. Waiting until prices stabilize reduces the loss. Some users wait 30-60 days before withdrawing to let fees offset the loss.
