PancakeSwap pools allow you to provide liquidity by adding your tokens to Liquidity Pools.
When you add your token to a Liquidity Pool you will receive Liquidity Pool (LP) tokens.
As an example, if you deposited CAKE and BNB into a Liquidity Pool, you would receive CAKE-BNB LP tokens.
The number of LP tokens you receive represents your portion of the CAKE-BNB Liquidity Pool.
You can also redeem your funds at any time by removing your liquidity.
Providing liquidity is not without risk, as you may be exposed to impermanent loss. “Simply put, impermanent loss is the difference between holding tokens in an AMM and holding them in your wallet.” - Nate Hindman
It’s not all bad for liquidity providers as you will also be given a reward in the form of trading fees. Whenever someone trades PancakeSwap, the trader pays a 0.2% fee, of which 0.17% is added to the Liquidity Pool of the swap pair they traded on.
There are 10 LP tokens representing 10 CAKE and 10 BNB tokens.
1 LP token = 1 CAKE + 1 BNB
Someone trades 10 CAKE for 10 BNB.
Someone else trades 10 BNB for 10 CAKE.
The CAKE/BNB liquidity pool now has 10.017 CAKE and 10.017 BNB.
Each LP token is now worth 1.00017 CAKE + 1.00017 BNB.
To make being a liquidity provider even more worth your while, you can also put your LP tokens to work whipping up some fresh yield on the CAKE Farms, while still earning your 0.17% trading fee reward.