Blockzeit
  • News
    • Business
    • Politics
    • Metaverse
    • NFTs
    • Markets
    • Investing
    • Technology
    • Trends
  • Tools
    • Crypto Charts
    • Crypto Heatmap
  • Education
    • Reviews
    • Guides
    • Bitcoin Price Analysis
  • Crypto Exchanges
No Result
View All Result
  • EnglishEnglish
    • EnglishEnglish
    • DeutschDeutsch
    • PortuguêsPortuguês
Buy Crypto
  • News
    • Business
    • Politics
    • Metaverse
    • NFTs
    • Markets
    • Investing
    • Technology
    • Trends
  • Tools
    • Crypto Charts
    • Crypto Heatmap
  • Education
    • Reviews
    • Guides
    • Bitcoin Price Analysis
  • Crypto Exchanges
No Result
View All Result
Blockzeit
No Result
View All Result
Home Education
swim ring 84625 1280

swim ring 84625 1280

How Do Liquidity Pools Work?

Aaron Moses by Aaron Moses
July 25, 2021
in Education
Reading Time: 3 mins read
0
Share on FacebookShare on TwitterShare on LinkedinShare via WhatsappShare via Email

Smart contracts were what gave birth to DeFi. However, liquidity pools (LPs) are what make DeFi markets viable. Liquidity pools are the backbone of decentralized exchanges as without them they wouldn’t exist. So, how do liquidity pools work?

Why do we need liquidity pools?

In stock exchanges and centralized crypto exchanges, market makers provide liquidity to the market by always buying or selling a given holding. This means retail buys and sellers don’t have to wait hours to find a buyer/seller to match their trade. However, conventional market makers do not work in DeFi.

And Ethereum conducts 12-15 transactions per second and has a blocktime of 10-19 transactions per second. This means that traditional market markers in DeFi would result in an unusable platform that is over priced and egregiously slow. Unfortunately, layer 2 protocols which improve transaction times aren’t a solution here either. This is because this system also relies on market makers. Furthermore, this would mean any time someone wishes to conduct a trade, they would need to deposit and withdraw their assets from the layer 2 protocol. So, this would add a cumbersome two extra steps for one single transaction.

This is why liquidity pools were invented. They provide liquidity to decentralized exchanges.

What are liquidity pools?

A liquidity pool is a place where token holders can lend their tokens so that there is at all times a ready supply of tokens ready when an order comes through a decentralized exchange. In exchange token holders receive a proportional percentage of the fees from all the transactions made. Liquidity pools are a profound invention in that they eliminate the need for a centralized order book.

The basic liquidity pool comprises of two token holdings. One can think of every liquidity pool as it’s own market for that specific coupling of tokens. When a liquidity provider adds liquidity to a pool, they are given LP tokens that are corresponding to the the liquidity they supply. Every trade that is made a fee is dispersed among all the the LP token holders. Liquidity pools therefore allow you to earn interest or passive income on your investment. Depending on the token this can be quite substantial.

No two liquidity pools are necessarily the same. We mentioned market makers above. A key mechanism of liquidity pools is a variation of market makers called AMMs (Automatic Market Makers). And different liquidity pools across converging platforms like Uniswap and PancakeSwap, for example, differ slightly. But essentially the takeaway here is a variant of the automated market makers protocol is omnipresent in liquidity pools.

The larger a pool is, the more easier it is to trade. Therefore, protocols can motivate token holders to join a liquidity pool by rewarding them with additional tokens. This is what’s known as liquidity mining.

Liquidity pools are the backbone of decentralized exchanges. Without them they couldn’t exist.

Liquidity pools versus staking

Liquidity pools are often confused with staking, but there is a big difference, although both of them can be lucrative. Staking you place your coins in a specific place to help secure the network (proof of stake) usually earning transaction fees. Liquidity pools, however, where invented with the sole purpose of lending your money to provide liquidity to the market.

Final thoughts

Liquidity pools have their risks as well. There have been instances of hacks and bugs in liquidity pools before. Still, LPs are a novel invention that are becoming better developed every day. The invention of liquidity pools is what made decentralized exchanges possible and allows it to challange centralized financial structures.

This article is not financial advice. Please do your own research before lending your assets to a liquidity pool.

If you enjoyed this article, you might also want to read about: WaterWood Finance: Solving Inflation

Aaron Moses
Aaron Moses

Aaron is passionate about blockchain and has been an investor in cryptocurrencies for the past years. He enjoys engaging with other people in the cryptocurrency community online, particularly on Telegram, and learning from experts.

Previous Post

What Are Stable Coins?

Next Post

Bitcoin Price Surges Back To $38K – Altcoins Follow

Related Posts

Avoid being a victim of crypto pump-and-dump schemes. (Photo Source: Flickr)

Crypto Pump And Dump: Red Flags That Lead To Them

by Giancarlo Perlas
February 2, 2023
0

Crypto pump and dump often leaves vulnerable investors who missed selling from the peak with a very low valuation of...

Crypto research  source: Nansen

Top 5 Essential Crypto Research Tools for Investors

by Edmond Herrera
February 2, 2023
0

Discover the top 5 essential crypto research tools for investors. Get hard to acquire information on news and chains –...

Cryptocurrencies now fall under the "Digital Asset" reporting in the updated 1040-SR form of the IRS. (Photo Source: Wikimedia Commons)

Here’s How To Properly Declare Your Crypto To The IRS

by Giancarlo Perlas
January 31, 2023
0

With the stricter regulations in federal income tax reporting that now include digital assets, there’s a need for cryptocurrency owners...

Load More

Get updates to your inbox!

Subscribe to our mailing list to receive daily updates!

FOLLoW US:

Blockzeit Logo 10 1

Blockzeit was founded in 2021 in Switzerland with the mission of bridging the gap between the complex blockchain technology and the general public. Blockzeit is a news and education platform that aims to make blockchain more accessible and bring more transparency to the scene.

Popular Categories

Categories
  • Bitcoin News
  • Business
  • Education
  • Investing
  • Markets
  • Metaverse
  • NFTs
  • Politics
  • Press Release
  • Switzerland
  • Technology
  • Trends
  • Uncategorized

Important Links

  • Privacy Policy
  • Disclaimer
  • About us
  • Contact us
  • Blockchain Jobs
  • Events

Contact & Social

For guest posts, contact us via info@blockzeit.com

 

Contact: info@blockzeit.com
Press: press@blockzeit.com

Facebook Twitter Linkedin Instagram
  • Home
  • Markets
  • Investing
  • Technology
  • Trends
  • NFTs
  • Education
  • Events
© Copyright by Blockzeit.com. All rights reserved.

Disclaimer

Start making money with crypto.

Buy Here
No Result
View All Result
  • News
    • Business
    • Politics
    • Metaverse
    • NFTs
    • Markets
    • Investing
    • Technology
    • Trends
  • Tools
    • Crypto Charts
    • Crypto Heatmap
  • Education
    • Reviews
    • Guides
    • Bitcoin Price Analysis
  • Crypto Exchanges
  • DeutschDeutsch
  • PortuguêsPortuguês

© 2021 Blockzeit by Blockzeit.