How do liquidity providers earn fees, and what is impermanent loss?

Putting tokens into a pool

A pool only works if someone deposits both of its tokens. Uniswap's documentation says the first liquidity provider sets the pool's starting price.¹ Later providers must deposit both tokens in proportion to the current price. If they don't, arbitrage traders can take part of what they added.¹

In return, the pool gives them liquidity tokens, often called LP tokens. They record each provider's share of the pool.^2,1 An outside article quoted in Uniswap's v2 documentation calls them a bookkeeping tool that keeps track of what each provider is owed.³

The v2 whitepaper says that when someone adds to an existing pool, the number of new LP tokens depends on how much is already there.⁴ Add 1% to the pool's reserves and you get new LP tokens equal to 1% of those already issued.^4,3

The form of the LP token depends on the version.⁵

• Uniswap v2 issues ERC-20 pool tokens, each a share of the whole pool.⁵
• Uniswap v3 records each position as an NFT, because each provider picks their own price range.⁵

To take their money out, providers "burn" their LP tokens and receive their share of the pool, plus their share of fees.¹

Earning fees

Uniswap's documentation says the 0.3% fee on each v2 trade is shared out pro rata, in proportion to each provider's share.¹ In v2 the fees are added to the pool's reserves, so they build up inside the pool. In v3 and v4, providers collect them separately.⁶

As Lesson 4 noted, Uniswap's documentation says a protocol fee takes 0.05% of each v2 trade, so v2 providers now get 0.25%.⁶ It has applied since December 2025 on Ethereum, and later elsewhere.^7,8

Impermanent loss

When the market price of one token moves, arbitrage traders trade with the pool until its price matches.^3,4 If one token gets more valuable, the pool ends up holding less of it and more of the other.³ So a provider's share can end up worth less than if they had just held the two tokens.

Uniswap's v2 documentation, quoting the same outside article, gives a formula for this gap, where the price ratio is the new price divided by the price when the provider deposited:³

impermanent loss = 2 × √(price ratio) ÷ (1 + price ratio) − 1³

The quoted article also lists results.³

The loss is the same whichever way the price moves: a doubling causes the same loss as a halving.³ It is called "impermanent" because it disappears if the price returns to where it was when the provider deposited.³

Fees can make up for it, or not. The same article says it is hard to know the balance between fee income and losses from price moves without knowing how much trading happens in between.³

Concentrated liquidity

Uniswap v3 changed how providers supply tokens. Its whitepaper calls the defining idea "concentrated liquidity": liquidity limited to a price range.⁹ Before v3, each provider's tokens were spread across every price from zero to infinity.¹⁰

Uniswap's documentation gives an example. A v2 DAI/USDC pool used only about 0.50% of its money for trading between $0.99 and $1.01, where most of its trading happened.¹⁰ In v3, a provider could put everything in that range instead, so traders get deeper liquidity near the price and the provider can earn more fees from the same money.¹⁰

There is a catch. If the price leaves a provider's range, their position stops earning fees and is left holding just one of the two tokens.⁹ Uniswap v4 keeps this design, and adds "hooks": extra contracts that can be attached to a pool to change how it behaves.^10,11