About 1.7 billion people globally do not have bank accounts, making up about 25% of the world’s population without access to traditional financial institutions.
The rise of cryptocurrency and decentralised finance (DeFi) offers a feasible option, enabling individuals to handle their banking requirements and access various financial services. DeFi uses liquidity pools to deliver these services, linking traditional finance to decentralised financial systems.
A Guide to Liquidity Pools
A liquidity pool is a smart contract that holds digital assets for decentralised finance (DeFi) on decentralised exchanges (DEXs). By pooling their assets, users can earn rewards based on their contributions. This system automates trades by using the tokens in the pool, eliminating the need for third-party intermediaries to match buyers and sellers.
How Do Liquidity Pools Operate?
The smart contract governs liquidity pool operations, with AMM algorithms setting and adjusting token prices according to supply and demand. Investors contribute tokens to the pool and earn a share of trading fees or investment rewards based on their liquidity contribution.
Why Liquidity Pools Matter?
Liquidity pools facilitate crypto trading without central intermediaries, minimising counterparty risk and reducing exposure to issues like employee theft. This leads to faster and more efficient trades, eliminating price gaps between buy and sell orders.
Automated trading within these pools ensures immediate execution with minimal slippage, removing spreads. Participants are rewarded for providing liquidity and contributing to a more efficient and transparent trading environment.
How to Get Involved in a Liquidity Pool?
Choose a platform like Uniswap, SushiSwap, or Curve based on your preferred assets, rewards, and interface to join a liquidity pool. Connect a crypto wallet like MetaMask and select a trading pair, as returns vary by pool functionality and assets.
Add liquidity by depositing tokens of the selected pair into the pool. In return, you’ll receive LP tokens representing your pool share. Trading fee rewards are typically deposited automatically and can be redeemed when you exchange your LP tokens.
Popular Liquidity Pools
Uniswap, a decentralised exchange protocol on Ethereum, has transformed liquidity allocation by enabling users to redeem ERC-20 digital tokens directly from their wallets. Its innovative AMM model leverages smart contracts to streamline trades, ensuring continuous trading and effective price discovery.
Uniswap’s ease of use, low fees, and permissionless access have contributed to its popularity, making it accessible to anyone interested in providing liquidity.
SushiSwap, another decentralised protocol on Ethereum, also employs an AMM system to facilitate liquidity for token pairs, allowing users to earn fees from their contributions.
PancakeSwap, operating on the Binance Smart Chain, further enhances this model by using AMM to replace traditional order books, offering users the opportunity to earn fees and rewards by staking tokens in liquidity pools. Its native token, CAKE, is crucial for governance and incentives.
Conclusion
The dynamic nature of the crypto market demands a variety of cryptocurrencies to operate efficiently. Liquidity pools are a crucial innovation in decentralised exchanges, enabling swift transactions even on volatile networks. By supplying essential assets, liquidity pools ensure platforms can maintain smooth operations.
