DeFi Liquidity Pools ! How do they work?
Let's begin this topic with understanding DeFi , it is an abbreviation for Decentralised Finance which is a system where financial products become available on the public decentralized Blockchain network. The main goal is to remove intermediate parties in financial transactions.
In decentralized exchange such as pancake swap or the unicorn swap, there is a lot of liquidity-related challenges, to solve this DeFi liquidity pool was created. " Liquidity Provider's" or in other words people who provide liquidity to a liquidity pool form a smart contract and lock their funds for a certain duration.
Usually, in a centralized exchange there is like this Trade book where it maintains a record of who bought or sold token at a certain price. In decentralized exchange buyers and sellers come to an agreement on the price of the asset based on the supply and demand.
"The working with robiniaswap token example!"
.png)
So here we have two assets one is the steem coin we own and the other is the RBS token that we need. Here basically we want to trade bsteem for RBS, usually, on a centralized exchange we would have to first wait for someone to match our trade price and then the trade occurs but In a liquid pool, they can do this by just depositing their funds (bsteem) and then they are rewarded over time based on the amount of funds deposited. In case if you want to withdraw from a liquidity pool you burn the tokens and then withdraw it from the stake but i would advise to look at the bigger picture and actually compound the investment. It's a nice way to make some decent passive income usually without any loss other than the gas fee.
This process depends on the fact there are enough buyers and sellers to maintain liquidity, its the market makers' job to ensure that there is always people who meet the demand and another task would be to keep the price fair.
It is kind of similar to mining where we verify transactions and are given a small amount of the token as a reward. The token reward is usually of the same crypto they are mining.
Benefits
✓ It benefits the decentralized exchange in maintaining the liquidity of tokens.
✓The Liquidity providers receive profit from holding the crypto in the pool.
✓Some pools even offer additional rewards to liquidity providers so that the token pool remains large and there is less chance of slippage.
.png)
Risks
✓If the size of the pool is small there is a larger chance of slippage.
✓ The whole system works on the basis of a smart contract, there are times when the smart contract may fail.
If you want to get started investing in liquidity pools check out my previous blogs on how you can transfer your steem to a robiniaswap pool!
This is by no means financial advice but a blog with the goal to educate everyone on the topic "liquidity pools"
Hope you learned something new, Let me know your thoughts on liquidity pools in the comments :^)
Useful Links:
WEBSITE: Robiniaswap
Discord Channel:RobiniaDiscord
Hi @the-prithvi
Thanks for bringing up this topic. Understanding what liquidity pools are, how do they work and why do we need them in the first place is a must for anyone who want to be involved in DeFi. Wouldn't you agree?
(actually, I'm not even sure if platforms like pancakeswap, uniswap or robiniaswap should be considered DeFi. Simply because those seem to be centralized projects. I wonder why don't we call it CeFi instead? Any idea?)
Back to main topic:
I find it quite difficult to understand. If we do not need to "match" seller with buyer, then what dictate price of the token? Usually those are buyers and sellers.
Solid read. Upovted already :)
ps.
could you perhaps check out my latest post (MINING RobiniaSwap (RBS) Tokens? Could you be making one of these mistakes?) and help me bring more traffic to it by resteeming this publication?
Cheers, Piotr
hii @crypto.piotr ,
In a centralized exchange, you can sell the token at any price if the buyer is willing to purchase it at that price. To answer your question, I think that the token price depends on the demand for that coin . This means if there is high demand then the price of the token increases and if low demand then the price of the token decreases.
In a pool exchange, the price is determined by supply and demand also in comparison with the paired token.
Also commented and resteemed your post on your latest post !
hi @the-prithvi
I've small question related to liquidity pools and impermanent loss.
I'm trying to wrap my head around it and based on my understanding:
in that case I would need 5000 RBS tokens and 1000 usd worth od BUSD. Is that correct?
Now, what would happen if price of RBS would:
a) scenario one: RBS would drop down to 0.1$ (50% drop)
b) scenario two: RBS would go up to 0.4% (100% increase)
I presume that the moment I exit liquidity pool, then I would end up still with 1000usd worth of BUSD, but amount of RBS tokens would be different.
Now, my question is: how many RBS tokens would I have at the end of the day (depending on the scenario).
Enjoy your weekend buddy,
Yours, Piotr
Hii @crypto.piotr,
This is a good question, The moment you exit the pool you will receive the 1000BUSD that were locked during the staking period.
The amount of tokens you have at the end of the day depends on the apr(annual percentage rate) throughout the day. The apr is based on how many transactions your tokens have validated throughout the day. The more tokens locked the more the chance of gaining rewards. I am not sure how the price of RBS token will affect the current apr.
The current apr for BUSD is: