Liquidity Provider

LP Token

Mooncake adopts a single-token liquidity pool model. When liquidity providers (LPs) deposit the underlying token into the pool, it is split into a Funding Position and a Leveraged Position, which together form the trading pair. LP tokens earn returns from two sources:

1. Trading Fees: When mUSD or Leveraged Tokens (LT) are minted or redeemed, a swap occurs between Leveraged Positions and Funding Positions, generating trading fees for LPs.

2. Funding Fees: Because the Liquidity Pool holds Funding Positions, LP tokens benefit from the price appreciation of these Funding Positions as they accrue funding fees

Mooncake uses the oracle price of the underlying token and the funding rate to calculate the USD value of both Funding Positions and Leveraged Positions.

The exchange rate is defined as:

$$Exchange\ Rate = \frac{\text{Funding\ Position\ Dollar\ Value}}{\text{Leveraged\ Position\ Dollar\ Value}}$$

This exchange rate determines the swap ratio between Funding Positions and Leveraged Positions inside the AMM.

The risks of LP Tokens?

Because the proportions of Funding Positions and Leveraged Positions inside the Liquidity Pool may drift away from the target leverage composition, the performance of LP tokens can deviate from that of the underlying token.

For example, when demand for Leveraged Tokens is high, the Liquidity Pool will hold a smaller proportion of Leveraged Positions. In an upward-trending market, this may cause LP tokens to underperform the underlying token.