As the need for a marketplace for crypto assets grew, several centralized exchanges came into existence. These exchanges use order books to create liquidity for the market. An order book is a list of buy or sell orders placed on the exchange. These orders are matched, that is, if there are two orders to buy 1 ether at $1,000 and one order to sell 2 ethers at $2,000, both orders will be closed when exchanging ETH. With this method, liquidity and price volatility depend on how many orders are in each book. If a user wants to buy 10 BNB for $300 and there is no corresponding sell order, the transaction will remain unexecuted.
Decentralized exchanges solve this problem by creating liquidity pools. Liquidity pools are reserves of crypto assets contributed by users and stored on the network. If a person wants to buy 3 SOL with 10 USDT, instead of waiting for a corresponding sell order, they can look for a SOL/USDT liquidity pool with a suitable floor price and exchange their USDT for SOL.
How does Curve Finance work?
Curve is a decentralized exchange that contains multiple liquidity pools (called curve pools) that allow users to add liquidity to the network (by depositing their tokens) or trade their stablecoins. Curve creates a decentralized marketplace for stablecoins.
The Curve pool is a smart contract deployed on the Curve protocol, and it comes in three types: A simple pool contains two or more stablecoins that can be traded against each other. Credit pools contain wrapped tokens and enable lending on supporting platforms. For example, Y-Pool is a credit pool that allows users to deposit DAI, USDC, or USDT. These deposits are automatically packed into Ytokens (i.e. yDAI or yUSDT) and stored in the pool. The originally deposited token (DAI, USDC or USDT) is borrowed on yearn.finance. The liquidity provider receives rewards from yearn.finance pool exchange fees and interest.
To provide liquidity to pools, Curve Finance issues LP tokens that can be staked or escrowed in the metapools for higher rewards.
How does Uniswap work?
Uniswap is a decentralized exchange that allows trading of ETH and Ethereum compatible tokens. These tokens do not need to be listed and users do not need an account to trade. In order to create liquidity pools, the liquidity provider is expected to deposit two equivalent ERC-20 tokens or ETH. So to create a liquidity pool of 1 ETH/USDC, the liquidity provider needs to deposit 1 ETH and the equivalent of 1 ETH in USDC. Other users can increase the liquidity of existing pools by depositing pairs of equals.
Uniswap charges a fee of 0.3% for each swap. These are distributed to all liquidity providers in the pool as liquidity tokens. The amount of liquidity tokens each provider receives depends on the amount of each token deposited in the pool.
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