Why Don’t You Make Money as a Liquidity Provider (LP)? Unveiling the 5 Pitfalls of DeFi Staking

Introduction

Many users enter DeFi, excited by the high APY (Annual Percentage Yield) of liquidity mining, and eagerly invest their funds. However, after a few months, they not only fail to earn profits but even see their principal shrink.

Why doesn’t your liquidity staking generate profits?
Today, we’ll thoroughly analyze the real reasons LPs don’t make money from five perspectives: Impermanent Loss, fee income, token depreciation, liquidity pool structure, and market manipulation—and provide solutions.

1. Impermanent Loss: The Biggest Enemy of LPs

What is Impermanent Loss?
When you provide liquidity to an AMM (Automated Market Maker), your funds are deposited in a 50/50 ratio into two tokens (e.g., ETH/USDC). If one of the tokens experiences significant price volatility, the value of your asset portfolio will be lower than simply holding the two tokens. This is impermanent loss.

AMM Calculation Rule (X*Y=k)
Suppose you originally hold 1 ETH priced at $2000. If ETH rises to $4000:

If you don’t provide liquidity (just hold):
- Your 1 ETH is now worth $4000, plus the original $2000 USDC.
- Total value = $4000 + $2000 = $6000.
But as an LP, the pool automatically adjusts prices:
- According to the rule ETH × USDC = constant, and the new price requires USDC/ETH = 4000:
  - Solve the equations: X*Y = 2000, Y/X = 4000.
  - New ETH amount = √(2000 / 4000) ≈ 0.707 ETH.
  - New USDC amount = √(2000 × 4000) ≈ $2828.
- Your liquidity is now worth: 0.707 ETH × $4000 + $2828 ≈ $5656.

Case Calculation

You deposit 1 ETH ($2000) + $2000 USDC (total value $4000).
If ETH rises to $4000, your pool adjusts to ~0.707 ETH + $2828 ≈ $5656.
If you simply held 1 ETH + $2000 USDC, your total value would be $6000.
Impermanent loss = $6000 – $5656 = $344 (~5.7%).

Conclusion: The greater the price volatility, the more severe the impermanent loss—it can even swallow all your fee earnings.

2. Low Fee Income: LP’s Real Returns Are Overestimated

Many DeFi projects advertise “ultra-high APY,” but actual earnings may fall far short due to:
(1) Insufficient Trading Volume

If a liquidity pool has low trading volume, fee income will also be low.
Example: A pool with $10M TVL but only $1M daily volume generates just $3000 in fees (0.3%), distributed among all LPs—yielding minimal returns.

(2) Depreciating Farm Token Rewards

Many projects incentivize LPs with governance tokens (e.g., UNI, CAKE), but these tokens may keep declining.
Example: A pool shows 100% APY, but 80% is paid in a project token. If the token’s price halves, real returns drop to ~20%.

3. Token Depreciation: LP’s Principal Erosion Risk

(1) Staked Tokens Themselves Depreciate

If you provide ETH/BTC liquidity and ETH drops 50%, even with good fee income, your principal shrinks significantly.
Being an LP ≠ HODL (long-term holding). In a downtrend, LPs may lose more than holders.

(2) High Risk of Shitcoin Pools

Many new projects lure LPs with high APYs, but their tokens may go to zero (e.g., meme coins, rug pulls).
Example: A “Dogecoin clone” pool offers 1000% APY, but the token crashes 90% in a week—LPs lose everything.

4. Liquidity Pool Structure Issues: CLMM vs. Traditional AMM

(1) Traditional AMM (e.g., Uniswap V2)

Liquidity is evenly distributed across all price ranges, leading to high impermanent loss.
Suitable for stablecoin pairs (e.g., USDC/USDT) but not volatile assets.

(2) Concentrated Liquidity AMM (CLMM, e.g., Uniswap V3)

LPs can set custom price ranges (e.g., ETH between $1800–$2200).
Risk: If the price exits the range, LP funds convert to a single asset, missing gains or suffering deeper losses.

Case:

You provide ETH liquidity in the $1800–$2200 range, but ETH surges to $2500. Your funds turn entirely into USDC, missing the upside.

5. Market Manipulation: “Scientists” Snipe LPs

(1) Sandwich Attacks

Bots detect your large trade, buy first to pump the price, let you buy high, then sell immediately to profit.
Result: Your trade suffers higher slippage, and bots siphon LP earnings.

(2) Liquidity Drain

Whales suddenly withdraw liquidity, causing poor pool depth and violent price swings—LPs bear extra losses.