The importance of liquidity
Low liquidity in a trading pair can have an outsized impact on the price of one or both cryptoassets. The lower the liquidity in a trading pair, the less likely the value of one or both assets is correct. Lower liquidity also leads to slower trades and greater slippage. Slippage occurs when the expected price of a trade differs from the price at the time the trade was executed.
Low liquidity can render a market virtually unusable. DEXs maintain healthy levels of liquidity by passing a portion of DEX trading fees on to people adding liquidity.
The basics of adding liquidity
Each DEX trading pair has its own liquidity pool. These are called “pools” or sometimes “liquidity pools”. For example, the popular trading pair VERSE-WETH on the Verse DEX has a deep liquidity pool that is half VERSE and half WETH.
Technical details may vary but generally follow the same pattern. A smart contract accepts specific cryptoasset deposits. The limitations of what is accepted and in what proportion may differ. For example, most DEX liquidity pools represent trading pairs, meaning that depositing into the pool requires an equal amount of the two crypto assets that make up the pair. The VERSE WETH pool requires VERSE and WETH of equal value based on the current market price of the DEX.
Funds may or may not be locked for a period of time after depositing in the pool. On the Verse DEX, your funds can be withdrawn at any time. The smart contract mints and sends you a token, which is a kind of receipt. This token is used to realize pending rewards from your position and withdraw your deposited crypto assets. The ratio of returned cryptoassets may be different than when you started.
DEXs usually provide an overview of the returns you can get from their pools, such as: B. this VERSE-WETH analysis page.
What you need to provide liquidity on a DEX
You need three things to provide liquidity on a decentralized exchange:
- digital wallet
- cryptocurrency
- DEX site
digital wallet: These wallets, also called crypto wallets or Web3 wallets, contain cryptocurrencies and other digital assets. The best wallets are self-sustaining like the Bitcoin.com wallet. Self-custody means you have full control over the contents of the wallet, while with custodial wallets a third party has ultimate control. Learn more about self-government and what it means here.
cryptocurrency: The wallet must contain cryptocurrency to pay and exchange transaction fees. Transaction fees are used to pay for actions that make changes to a blockchain. You will be paid in the local currency of the blockchain. For example, ETH is used to pay transaction fees on the Ethereum blockchain. Since pools usually consist of a pair of cryptoassets, you need such a quantity of these two cryptoassets that they have the same value. For example, 1 ETH could be valued at 1600 USDC, so if you provide 0.25 ETH, you will need 400 USDC.
DEX site: It is important to use a reputable decentralized exchange that also has good volume. The next section presents such an exchange.
Introducing Verse DEX Pools
Verse DEX pools allow you to earn a proportional share of the fees generated on the trading pair you fund. Specifically, 0.25% of trading volume is paid out to Liquidity Providers (LPs). This means that if you were the sole liquidity provider for the VERSE-WETH pool and the pool reached $100,000 in volume, you would earn $250 in fees. If you and another person each provide 50% of the liquidity to the VERSE-WETH pool and the pool achieves $100,000 in volume, you would each earn $125 in fees, and so on.
You can track your LP position on the Verse DEX Pools tab to see how much you’ve earned. Third-party DeFi tools like Debank will also show you your LP positions.
key terms
liquidity — Liquidity is arguably the single most important measure of the health of any market, whether crypto or traditional. In an exchange, liquidity is a measure of how easily two assets can be exchanged without the price of either asset changing drastically. For example, imagine you trade 1 ETH for 1500 USDC and the next person trades 1 ETH for 2000 USDC. The price on this exchange has changed dramatically after just one relatively small transaction. This exchange’s ETH-USDC pair would be considered poorly liquid.
Learn more about liquidity in this great introduction.
Pool (Liquidity Pool) — A pool refers to a collection of funds for a trading pair (e.g. VERSE-WETH) on a DEX. Individuals who provide liquidity in a pool receive a share of the fees traded.
Liquidity is so important that DEXs often incentivize participation in liquidity pools in addition to a share of trading fees.
exchange fee — A small percentage of each swap is paid to the exchange to facilitate trading. On the Verse DEX, you can see the exchange fee by tapping the View Exchange Details text above the Exchange Preview button.
How to contribute to pools and earn income
Injecting liquidity into a DEX is straightforward. Check out the APY on the different pools that DEX offers. Once you have found an interesting pool, deposit the specified crypto assets for that pool. The DEX provides a place to track your rewards.
Unfortunately, DEXs make design choices that make this process easier or more difficult. The Verse DEX is designed to be easy even for a beginner. For step-by-step instructions on how to contribute to pools with Verse DEX, use this support article.
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