Hi everyone!
- I hope all friends are fine and doing their good job toady I'm here to share with you about liquidity pools in which i tell you how liquidity pools work, what are liquidity funds used for and what are risks of liquidity pools.
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1)How liquidity pools work?
- Automated Market Maker (AMM) changed the game. These are the key innovations that has enable on-chain transactions without need to purchase orders. Since a direct counterparty is not required to execute the transaction, traders can enter and exit positions of token pairs that are unlikely to have much liquidity in the buy order exchange.
- An order book exchange can be thought of as a pair, where buyers and sellers are connected by an order book. Transactions on Binance DEX, for example, are peer-to-peer because they take place directly between users' wallets.
Transactions with AMM are different. Trading in MMA may be thought of as a peer-to-peer contrast.
- As mentioned earlier, a liquidity pool is a pool of funds deposited by a liquidity provider on a smart contract. When trading with AMM, there is no trading partner in the traditional sense. Instead, trade with liquidity in the liquidity pool. The pool does not need to have a seller at that particular time in order for the buyer to make a purchase, and the pool has sufficient liquidity.
- When buying the last food coin in Uniswap, there is no seller on the other side in the traditional sense. Instead, those activities are managed by algorithms that control what happens in the pool. In addition, the price is also determined by this algorithm based on the transactions that take place in the pool. If you want to dig deeper into how it works, read the AMM article.
- Of course, liquidity has to go somewhere. And anyone can be a liquidity provider so that in a sense they can be seen as their counterparts. However, this is not the same as in the order book model because it interacts with the contract that controls the group.
2)What are liquidity funds used for?
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- So far, we've focused primarily on AMM, the most common use of liquidity pools. However, as already mentioned, total liquidity is a very simple concept and can be used in a variety of ways.
- One of these is harvest farming or liquid mining. The liquidity pool is the foundation of an automated revenue generation platform as needed, where users add funds to the pool and use it to generate revenue.
- Getting new tokens in the hands of the right people is a very difficult problem for crypto projects. Liquidity mining was one of the most successful approaches. Basically, tokens are algorithmically distributed to users who place the tokens in the liquidity pool. Custom tokens are distributed in proportion to the share of each user in the pool.
- Consider; It can also be a token from another liquidity pool called a pool token. For example, by providing liquidity to Uniswap or lending money to a compound, you can earn tokens that show your interest in the pool. You may be able to deposit those tokens in another pool and receive returns. These chains can be very complex, with protocols integrating pool tokens from other protocols into the product.
- Management can also be thought of as a use case. In some cases, a very high threshold symbolic voice is needed to submit a formal business proposal. Rather, if funds are pooled, participants can support common causes that they find important to the protocol.
- Another new DeFi sector is smart contract risk insurance. Many of those implementations also work in liquidity pools.
- Another more avant-garde use of liquidity pools is truncing. This is a concept taken from traditional finance and consists of the distribution of financial products based on risk and return. It is not surprising that these products allow MPs to choose their personal risk and return profile.
- Mining of synthetic assets on the blockchain also depends on the liquidity pool. If you add a little collateral to your liquidity pool and connect it to a trusted oracle, the assets you need will have a synthetic signature attached. Well, it's actually a more complicated issue, but the basic idea is very simple.
- What else can you think of? Liquidity pool uses may not yet be discovered, all depending on the ingenuity of the DeFi developer.
3)Liquidity fund risk
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- When providing liquidity to AMM, one needs to be aware of a concept called permanent loss. In short, if liquidity is provided to MMA, it is a loss of dollar value compared to HOD Ling.
- Providing liquidity to AMM can expose you to temporary losses. Sometimes it may be small. Sometimes it can get bigger. If you are considering investing in a bilateral liquidity pool, be sure to read this article.
- Another thing to remember is the risk of smart contracts. When you deposit funds in the liquidity pool, it is in the pool. Therefore, technically no intermediary holds your funds, but the contract itself can be considered the manager of those funds. For example, if a quick loan encounters an error or any vulnerability, the funds can be lost forever.
- Also note the project where the developer has the authority to change the rules managed by the group. Developers may have an administrator key or other privileged access within their smart contract code. This allows you to do potentially malicious things, such as managing funds within a group. Read articles about DeFi scams to avoid scams and try to get out of scams as much as possible.
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