Liquidity pools are nothing but smart contracts which makes it possible for you to trade tokens or coins irrespective of the availability of buyers and sellers out there.
In simple terms, there are pools of digital currency and before diving deep into this it’s imperative to know what made this concept originate in the first place. To know that let me brief you on how the traditional stock market works. They follow what we call an order book model. To begin with, a trade is transacted only if the price of both parties matches. At the end of the day no matter what you have to set your price at which the other party is willing to transact. It is very inefficient because the traders are investors have trouble with the difference between the expected price and the executed price. This is not just in traditional but also in crypto markets and you don’t have all the time in the world to wait until your set price meets that of buyers or sellers.
Why there is a need for liquidity pools?
So this is where the liquidity pools come into the frame. With this, there is no question of non-liquid markets. The liquidity users are given an incentive of share in trading fees for providing liquidity for shares. Why is it so revolutionary in the crypto market and how could you possibly make big bucks using this smart concept? To get the answers read the complete article.
First off would you believe if I said that the liquidity pools are nothing but just code? Well, it is in fact algorithms are the core reason for their efficiency. So when you give tokens to the liquidity pools it hacks the price of the token to maintain the ratio of 50-50. The math of the algorithm determines the cost of the token.
Does it sound all too technical well let me break it down for you with the help of an example? Let’s take basic attention tokens or bat and Ethereum for instance. So if you want the pool to trade one thousand dollars you need to give five hundred dollars basic attention token and 500 Ethereum. The algorithm that the liquidity pools use is that which consists of a bunch of large words. This is known as a constant product of automated market makers. So as you continue to pump Ethereum into the pool of 4 tokens the algorithm raises the price of every token you have to buy.
Let’s take an example the first time you buy a token it might cost you 30 dollars and subsequently 33, 39, 45, and so on. And by the time you are to buy 100 tokens, the price would have already skyrocketed and it would cost you anywhere around 100 easily. Anyway, this is in accordance with the math done by the algorithm. If you look from the lens of an algorithm it feels that the value of Ethereum is dropping since you are exchanging it to buy tokens. In order to maintain the ratio, it thus raises the current price bar for tokens.
A liquidity pool consists of assets you are willing to trade. So unlike the traditional market irrespective of the price in the market this concept allows you to buy or sell an asset. It is not as gimmicky as it sounds. Smart contracts are the core reason for a liquidity pool’s existence. These smart contracts are publicly viewable. So no worries the security audit information is transparent. Most importantly it allows you to trade at real-time market prices. This is very advantageous no wonder many decentralized platform leverage this. This is how digital assets are traded in an automated and permissionless way, allowing people to provide liquidity and receive rewards interest, or an annual percentage yield on their crypto.
For every transaction fee is charged that’s a petty thing for something so beneficial as this. In each trade, only a small percentage is charged. If you are wondering about these liquidity pool examples we have you cover it. In fact, popular platform operations are centered around it to name some examples uni swap, Pancakeswap, curve, and balancer are very popular. If you look at uni swap without needing a centralized service they allow you to trade any Ethereum for any other erc20 token and what makes it stand out is that it charges only a small amount as a fee.
The curve is a popular decentralized liquidity pool for stablecoins for those who don’t know stablecoins are not volatile reducing slippage. And last but not least balancer is a platform that offers scattered benefits to its liquidity providers. At present, it allows up to 8 assets in a single liquidity pool. This is crazy and not to forget this one shows limitless possibilities in decentralized finance by this time I am sure you are wondering what is in for the liquidity providers.
How do liquidity providers Earn Money?
A liquidity provider puts their money into the pool this is absolutely profitable you can earn from trading fees. This amount differs based on the percentage of their own liquidity pools. There is also another smart choice given to us by the decentralized exchanges and that is they hook up a couple of liquidity pools and in this way, if you have basic attention tokens you can trade them for graph tokens. So now you don’t have to trade bad for Ethereum the exchange will do two swaps to make this possible. This is more powerful and allows you to perform that trade directly even if there aren’t liquidity pools for the token you are willing to buy. The first swap is bad to Ethereum and the second swap is Ethereum to graph token.
Related: Why Decentralized Exchanges are the future of crypto trading?
Voila, this is what they do in cryptocurrency routing. It makes it effortless for users to swap their assets from different networks instantly. This smart technology is new and they are offering up to 500 percent apr. This is jaw-dropping for something in which there aren’t many investors by this we can derive that these exchanges make both loads of money. The more the investor number is the more the price stabilizes and your cut will also be reduced.