Decentralized Finance (DeFi) has generated an explosion that has resulted in a surge in on-chain activity. DEX volumes indeed contain the immense potential to compete with centralized exchange volumes.
Defi protocols have nearly reached a value of 280 billion U.S dollars as of November 2021. The ecosystem is rapidly broadening with the modern type of products.
However, what’s the actual reason behind the expanded growth? Well, liquidity pool is among the core technologies underlying all of these products.
What is a Liquidity Pool?
A liquidity pool is a compilation of digital assets to enable trading on a decentralized exchange (DEX).
DEXs require more liquidity than centralized exchanges because they don’t work on the same principle in place to match buyers and sellers.
This liquidity is added by users by purchasing on the bid and selling on the ask. To provide liquidity, users are required to add both assets represented in the pool.
Users use an Automated Market Maker (AMM), which is a set of fundamentally mathematical functions that lay down prices in accordance with supply and demand.
How Do Liquidity Pools Work?
Liquidity forms the backbone of DEX by applying the AMM system. The AMM system is where investors, or in this case “liquidity providers,” add equal values of stablecoins and the cryptocurrency coins – for example, ETH or USDC – into the pool.
This particular way can make users trade one stablecoin for another by exchanging the exact value of Ether or USD Coins. Liquidity Providers lay out a service for DEX buyers and sellers by facilitating them with readily available tokens for trading within the identical blockchain.
Moreover, Liquidity Providers must commence trading in an environment where no seller exists. So, if users want to buy specific coins but there isn’t anyone to sell them, the Liquidity Providers don the hat of the seller.
How To Make Money With Liquidity Pools?
In exchange for adding tokens into the pool, you can receive interest in the trading fees from the trades that users make within the pool. This phenomenon is known as liquidity mining.
Over time, you can earn anywhere between 2% and 50% annually through trading in liquidity pools.
Some LPs switch between various liquidity pools to raise their earnings. This is known as yield farming, where yield is the interest that traders earn by stalking crypto assets.
The Best Liquidity Pools
The hunt for superior liquidity pools has surged exponentially in the past years, mainly owing to the gains they provide.
However, if you’re still searching for the top liquidity pools, worry not! As the list below will guide you through the top liquidity pools.
1. UniSwap (Ethereum, Polygon, Optimism, Arbitrum)
UniSwap is a decentralized exchange (DEX) based upon the Ethereum blockchain that operates on a peer-to-peer trading system defined by Ethereum-based permanent and non-permanent upgradable smart contracts.
Versions of the token can also be found on the Polygon, Optimism, and Arbitrum networks.
The fact that UniSwap maintains an open-source exchange gives it a pushing edge. Other than that, this exchange enables anybody to create new liquidity pools for any token without fees.
Another feature that differentiates it from being at the top of liquidity pools is that it only has a 0.3% exchange charge, divided with liquidity providers based on their participation.
2. PancakeSwap (BNB Smart Chain)
PancakeSwap is a decentralized exchange that inherits the BNB chain and focuses on BEP-20 tokens specifically developed by Binance.
PancakeSwap shares some similarities with superior platforms like UniSwap. Users can trade their coins for others without the input of middleman services with a 0.25% transaction fee.
The reason behind its charm is that it is a fully decentralized exchange where the trades and orders are automatically executed through a smart contract.
3. Balancer (Ethereum, Polygon, Arbitrum)
Balancer is built on Ethereum, which functions as a non-custodial portfolio manager, price sensor, and liquidity source.
Users benefit from customizing pools while also earning trading costs by eliminating or expanding liquidity. The primary strength of Balancer is its modular pooling technique, and it supports different pooling configurations, including smart, private, and shared pools.
4. SpookySwap (Fantom)
Besides the basic DEX service, such as token swaps and adding liquidity, SpookySwap allows users to connect to other blockchains through its built-in cross-chain feature.
For example, you can bridge between Ethereum, Binance smart chain, etc. Interestingly, SpookySwap taps from the innovation of Fantom blockchain to provide these at low fees. With a near-zero swap fee of 0.2%, which gives it an edge over other DEXs.
5. Quickswap (Polygon)
Quick swap is a layer 2 decentralized exchange and AMM built on a Polygon network. It functions similarly to UniSwap regarding liquidity and earning transaction fees when users swap tokens from these liquidity pools.
Quick swap extends a bridge between the Ethereum blockchain and Polygon. Hence, users can trade and swap ERC-20 tokens on this platform with a 0.3% transaction fee.
Liquidity suppliers on Quickswap earn 0.25% of the fees generated from trades concerning their share of the pool.
6. Trader Joe (Avalanche)
Trader Joe is a favored AMM-based decentralized exchange built upon the Avalanche blockchain.
The primary function of Trader Joe’s is to work as an exchange platform for the users of the Avalanche Network. Users can use this decentralized exchange to trade AVAX and other cryptocurrencies with a 0.3% of the trading fee.
Are Liquidity Pools Safe?
Just like every other investment fund, DeFi also accompanies certain risks.
That said, liquidity pools have generated enormous popularity, and a growing amount of capital is situated in them.
Due to an increased number in adoption and growing stakes, more users have been involved than ever before to protect users’ funds through well-coded smart contracts.
Conclusion
Through automated smart contracts, liquidity pools eliminate the need for a centralized order book while significantly narrowing down the dependence on the external market to offer constant liquidity supply to decentralized exchanges.
