Liquidity pools are one of the best ways you can earn in DeFi (Decentralized Finance).
They offer both traders and investors a path they can both benefit from by providing liquidity and Earn rewards from your investment.
In traditional finance, trading typically looks like this:
Order book & liquidity pools
You need to match a buyer with a seller at a fixed point price (order book model). Both companies must meet at the price both parties are willing to commit to before a transaction goes through. This process takes time and often involves significant fees. But with liquidity pools, traders simply use the pool (rather than directly to a buyer or seller) to exchange assets with minimal fees.
Liquidity pools offer traders an easier and cheaper route while offering investors passive income with varying levels of risk. It contains liquidity pools DEXs (Decentralized Exchanges) as on Osmosis, Polkadot & Uniswap.
Liquidity pools are possible through smart contracts & AMMs (Automated Market Makers). These are innovative software codes that allow investors to earn rewards (returns) for providing liquidity to the platform by depositing their funds.
generate income
Investors can provide liquidity in a liquidity pool where they can earn up to 1000% APY (Annual Percentage Return) with a small additional risk. Liquidity pools are an excellent source of passive income for you in the truest sense of the word Earn income on your sleep. As an investment, it caters to all types of strategically nuanced pool providers. Conservative pool investors love pools tied to stablecoins Since stablecoins are tied to fiat (1 stable token = 1 USD), they offer a stable and steady return. While for the very brave investor, there is high risk with high reward pools like the pools tied to memecoins.
Be it defense or offense, you can find a liquidity pool for this fix.
ATOM token paired with stablecoin pool
PICTURE token pair with Osmo
how they work
Liquidity pools give you a return on fees when traders use the liquidity pool for an exchange. You earn over that transaction fees whenever someone exchanges tokens with the DEX. For example, let’s say you have invested in the $ATOM/$OSMO pool at osmosis.com. You contributed $5,000 (this would be split between the two, so $2,500 for each asset) to the pool with a TVL (total value locked) of $10,000.
Both you and John benefit from the pool
Let’s say John has a lot of $OSMO from the earnings he’s saved, now he wants to exchange those tokens for $ATOM to maybe cash out or take his winnings. This explains its need for the $ATOM/$OSMO pool. Every time a user like John uses the pool, you would earn a portion of that fee. Now that you are providing liquidity to half the pool, you would earn half the fee once he trades. Like John, many others trade too. If the total swap for the day is $100, you would earn a return of $50 for the day.
Liquidity Pool Risks
All investments involve risk.
- Ephemeral Loss. It simply means that if one of the tokens suddenly jumps in price while the other stagnates, you wouldn’t have made as much if you simply held the token.
- embargo Pools with osmosis have a lock-up period. The longer the lock-up period, the higher the APY.
Blocking periods for liquidity pools
A 14-day lock-up period offers the best prices. The disadvantages of this are if you don’t have instant access to your funds in emergencies e.g. B. when a token falls in price or when a stablecoin gradually depegs, as is the case with UST/LUNA. To counteract this, investors diversify between different lock-up periods.
- Bugs & exploits in the code– These are rare, but they do occur. Sometimes developers have cracks in their code, which are then exploited by some of their users. For this reason DYOR (Do your own research) is very important. Invest in projects you think are solid.
The central theses!
- Liquidity pools provide liquidity for two paired assets benefiting traders and investors
- Liquidity brings you great returns of up to 1000% APY with added risk
- Stablecoin pools are a great conservative investment that minimizes risk while giving you great returns
- Ephemerality loss means that if one paired with tokens skyrockets in price relative to the other, you wouldn’t have made as much if you just held
Edmond is a passionate writer for video games, GameFi and Web3. He has worked for top GameFi companies and video game/crypto news websites.
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