For the most part, Tolkien did not invent his supernatural entities, but he placed a striking stamp on them that was clearly influential. Tolkien was an expert in Medieval literature and languages, and he was particularly drawn to the supernatural as expressed in that body of writing. In addition, he was a consumer of the folklore that was being published before and during his lifetime.

European tradition - as expressed in Medieval literature and in folk narratives - included a spectrum of loosely-affiliated/related supernatural beings which could be enchanting, but which were always extremely dangerous. They inspired fear, respect, and caution. Some were taller than others; some had specific occupations, and others simply existed by pond or tree. Some were more pugnacious, and others could interact in a more kindly manner, but from the folk point of view, they were all to be avoided if possible because they were all dangerous and quick to anger.

Tolkien's "stamp" on all this, as he imported popular belief and tradition into his literary writings, was to place this spectrum of supernatural beings into fiercely-opposing good and evil realms. The Northern European folk were generally not comfortable with placing these supernatural beings into the realms of good and evil, even though their church advocated just this sort of dichotomy. That idea was good enough for angels and demons, saints and the Trinity, but when it came to these supernatural beings, the folk told stories about how they were neither good nor bad and how they had a chance at Redemption in the Final Hour.

Where the folk tended to have blurred lines that barely provided any sort of distinct categories, Tolkien teased these entities apart, creating distinct species with good or evil affiliation. The common root/inspiration for these can be found in an oft-cited premise Tolkien once gave voice to that orcs were originally elves who had been corrupted. He later distanced himself from that idea, but we can see in that fleeting moment, an acknowledgement that the folk core of this range of supernatural beings was originally a single spectrum with ill-defined differences.

As a side note (since /u/itsallfolklore did a good job answering the primary question), the fact that you wrote "dwarves" rather than "dwarfs" is thanks to Tolkien. He wrote in Appendix F to LotR:

It is to mark this that I have ventured to use the form 'dwarves', and remove them a little, perhaps, from the sillier tales of these latter days.

One presumes that the "sillier tales" to which he refers include the 1938 film Snow White and the Seven Dwarfs, which you will note uses the older spelling. But he did not make that decision as a response to the Disney film, as he writes in the 1937 forward to The Hobbit:

In English, the only correct plural of 'dwarf' is 'dwarfs' and the adjective is 'dwarfish'. In this story 'dwarves' and 'dwarvish' are used, but only when speaking of the ancient people to whom Thorin Oakenshield and his companions belonged.

Thanks primarily to Tolkien and those influenced by him, the English language itself is changing to the point where "dwarfs" as a plural noun looks wrong while "dwarves" looks and feels right, at least to my eyes ("dwarfs" to me would be a verb meaning "towers over").