As the DeFi space takes off, gigantic decentralized exchanges like Uniswap are playing a crucial role in attracting newcomers and retaining existing ones. The DeFi space, full of opportunities, promises outstanding returns due to its investment and trading strategy.
One way to make money in the cryptocurrency space is to become a liquidity provider or stake your money in return for incentives. There are numerous platforms where one can find these fruitful products, but choosing top-notch platforms is the priority of smart traders.
Have you ever wondered what strategies these platforms use to retain their users? If yes, you will find the answer here.
In this article, we will learn what DEX is and how some of the leading decentralized platforms have managed to attract liquidity providers.
What is DEX?
Don’t get confused with the acronym. DEX simply stands for decentralized exchange.
These decentralized exchanges are peer-to-peer marketplaces where crypto traders transact.
These exchanges attempt to fulfill one of the core capabilities of crypto, which is to ensure smooth transactions without the interference of traditional banks, brokers or other intermediaries.
This development is about unbanked people being able to transact through popular DEXs like Uniswap, Suchiwap, and others without having a bank account.
Decentralized Exchanges (DEXs) are Thriving; In the first season of 2021, $217 billion worth of transactions were processed through it.
As of April 2021, there were over two million DeFi traders active, a tenfold increase from the month of May 2020. Some popular DEXs include Uniswap, SushiSwap, PancakeSwap, and others.
While DEXs strive to attract liquidity providers, Bitcoin Up also offers a great way to facilitate trading.
What is a Liquidity Provider?
To best understand liquidity providers, it is good to understand what and how liquidity pools work.
Have you ever imagined or wondered how traditional banks are able to maintain continuous money transaction as if they are invincible because they are hoarding some money? Or with order books? Well, you can say that.
The same idea makes the liquidity pool interesting.
The liquidity pool is the fundamental technology supporting the DeFi ecosystem. This is a large digital sum of crypto tokens locked in smart contracts and provided by the platform’s users.
These funds are then used to support decentralized services such as lending, trading, and other functions.
So, liquidity providers deposit funds in the form of crypto assets into a pool that is used by other traders to carry out cryptocurrency swaps on exchange platforms such as Uniswap. Just as traditional banks help maintain balance in the financial world, liquidity providers are market makers.
These are companies or people who buy and sell assets on the financial market.
These traders conduct trades to maintain supply and demand and ensure that there are enough buyers and sellers in the market even during periods of low market demand.
In return for their liquidity, liquidity providers receive rewards in the form of interest, fees, or tokens for providing liquidity to DeFi protocols.
Why are liquidity providers important?
Liquidity providers offer many advantages. One of these advantages is that without a liquidity provider, investors will find it difficult to complete a trade at a reasonable price. Since they maintain the balance between supply and demand, they ensure a cheap and fair price in the market.
Another important aspect of these providers is that they help expand the trading market. Due to the fact that LPs invest a large amount of capital in this pool, the level of activity between buyers and sellers increases at the pace set by these LPs.
Additionally, prices in the market are likely to be more accurate and reflect the true value of assets, resulting in a safer market. Due to price differences, this increased activity can also present opportunities for traders to profit.
How do top DEXs attract liquidity providers?
According to Defilama, Uniswap, PancakeSwap and CurveFinance, among others, are among the largest DEXs by volume.
These decentralized financial platforms are becoming increasingly popular in the world of cryptocurrencies and blockchain. However, to ensure they attract enough liquidity and the right liquidity providers, these top DEXs employ a few strategies.
Some of these strategies include:
1. Providing high liquidity rewards
One of the key strategies that many of the top DEXs offer is high liquidity rewards or additional tokens. These are awarded to LPs as a reward for ensuring a sufficient supply of assets in the liquidity pool.
Curve Finance, for example, offers high yields on stablecoin liquidity pools. As a liquidity provider supplying equivalent stablecoins such as USDT and USDC to Curve pools, you can earn an annual percentage yield (APY) of up to 10-20%.
One interesting thing about this strategy is that it offers LPs the opportunity to double their returns on low-risk coins.
These returns are generated from trading fees and other attractive incentives on the platforms.
2. Offer low fees
In addition to providing high liquidity rewards, offering low fees is one of the tactics used to attract investors.
Because with low fees, investors or liquidity providers can maximize their profits.
For example, major decentralized exchange platforms like 1inch leverage this strategy by allowing traders to conduct low-cost token swaps. 1inch achieves this by operating across multiple DEXs such as Uniswap to offer lower fees.
By routing across multiple DEX platforms, 1inch is able to offer users the ability to pay lower fees of 0.1% or less per trade across token pairs.
In order not to ignore the interesting part, this platform gives the liquidity providers a certain share of the saved fees. This allows for better speeds and more even circulation of fluid pools.
3. Liquid mining programs
Now, among other things, it’s about how decentralized exchanges use liquid mining programs to attract liquidity providers to their platforms.
Liquidity mining is the process by which you lend digital currencies to a decentralized platform in exchange for rewards.
For example, Serum distributed its Ethereum-backed token at launch to desired users who were the first suppliers to its pool. Therefore, by staking and locking funds in the pool, Serum users were able to receive their bonuses from the pool.
While Serum was able to grow its total value to over $1 billion, users of this platform were also able to place higher stakes due to the success of the DEX.
So if you are looking for additional incentives, you could try DEX that offers liquid mining programs.
4. Have a large and active user base
A good and strong database is necessary for any decentralized exchange to achieve its goal of being among the best in the market. One way these DEX platforms achieve a strong, active user base and engaged community is through airdrops.
For example, in 2020, Uniswap airdropped its UNI governance token, which gained it over 10,000 active users. While those who traded or deployed tokens at some point on the platform also received additional incentives.
This strategy helped Uniswap become one of the largest decentralized exchanges in terms of liquidity and volume, and other growing platforms continue to use this platform to this day.
5. Ensure reliability, innovation and security
For any decentralized finance platform, building trust and ensuring reliable and fast transactions through innovative technology and security is one of the keys to ensuring the loyalty of liquidity providers.
Due to various news stories about scams, piracy, and the like, leading Dex companies like Uniswap are conducting many audits of their smart contracts through companies like Trails of Bits.
For example, in 2020, Uniswap responded quickly to resolve a fraud issue, preventing losses and sealing investor confidence.
In addition, the platform also improves features such as responsiveness and multiple trading interfaces to make it easier for users to navigate the platform and improve their trading experience.
Also Read: Revolutionizing Crypto Trading: Top 7 Decentralized Exchanges for 2023
Final note
While this article has explained what DEXs and liquidity pools are and the importance of liquidity providers to these decentralized platforms, it is important to note that some of the strategies used are still being used by new decentralized exchanges.
As an investor, it is good to take advantage of this opportunity when it arises. Therefore, it is important to note that blockchain technology is still evolving and there is still much to see and experience. Diversifying your investment is also the best trick to limit your losses.
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