Back in the early days of crypto trading, decentralized trading was quite new and at the stage of infancy. Due to this, early adopters faced a major problem while trading any asset because of the low liquidity and fewer traders. Hence to solve this problem, Various cryptocurrency exchanges came up with the concept of Cryptocurrency liquidity and ways to maintain it.
What is liquidity in cryptocurrency trading?
Liquidity is one such concept in the cryptocurrency markets that determine the amount of ease by which tokens can be swapped with any other token. For example, if you want to swap your Bitcoin for Ethereum, then it is important that the liquidity of Bitcoin and Ethereum is quite adequate so you can swap them easily.
There are two different ways by which liquidity can be maintained on crypto exchanges, one is through order books whereas the other one is the crypto liquidity pools. In this article, we will discuss some of the important concepts about crypto liquidity Pools.
What are Crypto Liquidity Pools?
Crypto Liquidity Pools are the backbone of any automated market makers or AMMs. Any Liquidity Pool on AMM is a smart contract that locks up the cryptocurrency for faster transactions and crypto trading in an automated way.
How does the crypto Liquidity Pool Works?
Whenever any user or Liquidity Provider locks up the cryptocurrency into the Liquidity Pool, they get some Liquidity Pool Tokens in return. These Liquidity Pool Tokens or LP Tokens represent the share of the user in the Liquidity Pool which can be further used to get the incentives and unlock the crypto tokens.
Some of the common Defi exchanges that work on the concept of Liquidity Pools are Sushiswap and Uniswap On Ethereum Network and Pancakeswap on BNB Chain.
Why do we need Liquidity Pools Crypto AMMs?
Whenever any trade is triggered in the market be it decentralized exchange or centralized exchange, there is always a difference between the executed price and the actual price. With the help of Liquidity Pool, this issue gets eliminated by offering some decent incentives to the Liquidity providers by giving a share of the trading fee.
Also, it opens up new opportunities for various crypto adopters to yield some passive income through this. Many times, it is expected that a liquidity provider can earn high incentives by providing liquidity.
Every trader can easily conduct trade without waiting for any other trader to sell or buy an asset. The trades on AMM are completely independent of any other trader and dependent upon the liquidity in the Liquidity Pool. If there is adequate liquidity then trade can be easily executed.
Some primitive use cases of Crypto Liquidity Pools are as follows.
This is one of the interesting use cases of the liquidity Pools. Liquidity Pools act as a foundation for various yield farming platforms like Yearn finance. Users can use these platforms and add their funds to yield rewards.
Whenever any new token is launched or a project, the developers can utilize the liquidity Mining concept to distribute tokens to their community members. The automated way of token distribution to the liquidity Providers helps to get a large number of tokens in the market for a seamless trading experience for the community members and generate more liquidity.
Crypto Liquidity Pools play a major instrument for governance. As it can be used to pool funds together which can help the participants to vote for any governance proposal that can lead to significant change.
How to start a crypto Liquidity Pool?
If you are looking to build the crypto liquidity Pool, then you need to go to the decentralized cryptocurrency exchanges such as Uniswap or Sushiswap. On those exchanges, you will get a choice to create a liquidity pool for any ERC20 token you want. Some of the steps to create a Crypto Liquidity Pool on Uniswap are the following.
Step 1: Add the tokens to your wallet for which you want to create a Liquidity Pool. For example, if you want to create a liquidity Pool for TokenA and TokenB, then you need to ensure that you have both the tokens in your wallet.
Step 2: Go to any crypto exchange like Uniswap or Suhiswap, Connect your wallet and open a liquidity Page on the exchange.
Step 3: A Application will open which you can use to create a Liquidity Pool by clicking on it. After that, add the basic details like the Number of TokenA and TokenB that you want to add to the liquidity Pool and Click the Approve button to Supply it.
Step 4: After you click on Supply Button you need to confirm to create a Liquidity Pool and Hit Enter. After a few seconds of transaction confirmation, you will be able to see your liquidity Pool.
How to use Liquidity Pool On Decentralised Exchanges?
In this section, we discuss how to use a liquidity Pool if it already exists on any Decentralised exchange like Uniswap or the Sushiswap. Many times it happens that the token pools are already there. In that case, you can try to earn some passive income by providing liquidity to the liquidity Pool.
To provide Liquidity to already existing Liquidity pools, you need to have tokens available in your wallet, as we discussed earlier.
Steps to Provide Liquidity to Liquidity pools are given below.
Step 1: Go to any crypto Decentralised exchange such as Uniswap. Once you have opened the website, connect your wallet by clicking on “Connect to a Wallet” in the top right corner.
Step 2: Choose the Pool to which you want to provide Liquidity. And search for the token in the search bar. Once you find the token, click on the “Add Liquidity Button”.
Step 3: Enter the amount of token for which you want to add liquidity, click on the Approve button and confirm the transaction.
Step 4: After the approval and transaction confirmation, click on Supply Button and Confirm it.
Liquidity Pools aims to simplify Decentralised Exchanges Trading by performing fast and seamless transactions in no time. Also, it opens up new opportunities for crypto investors to receive the rewards and earn interest on liquidity by providing it to various Liquidity pools. Also, most of the Liquidity pools do open source their code, which ensures its security of it. But most Liquidity Pools run in a competitive environment and attracting liquidity could be quite challenging but at the same time equally rewarding.
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