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Liquidity Pools Guide For Beginners Getting Started With Liquidity Pools

They are supported by other pieces of code, such as automated market makers (AMMs), which help maintain the balance in liquidity pools through mathematical formulas. To create a better trading experience, various protocols offer even more Liquidity Pools in Crypto incentives for users to provide liquidity by providing more tokens for particular “incentivized” pools. Participating in these incentivized liquidity pools as a provider to get the maximum amount of LP tokens is called liquidity mining.

what are liquidity pools in crypto

Such ease is essential to the DeFi ecosystem because of the numerous financial activities carried out in it. Bear in mind; these can even be tokens from other liquidity pools called pool tokens. For example, if you’re providing liquidity to Uniswap or lending funds to Compound, you’ll get tokens that represent your share in the pool. You may be able to deposit those tokens into another pool and earn a return.

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Liquidity pools replace this order book with a simple mathematical formula that automatically determines the price based on the ratio of assets in the pool. This eliminates the need for traditional market makers and allows for efficient trading even with relatively low trading volumes. However, Curve is uncommon because it does not yet have a native token, though one may be coming soon.

what are liquidity pools in crypto

To get a better understanding of how such a system works in the real world, let’s take a look at the following example. Liquidity, in this case, is comparable to having lots of employees who are there to serve you. On the other hand, in the case of an illiquid market, we can compare it to having just one worker available and plenty of customers. Obviously, this situation would lead to slower orders and inefficient work, which eventually leads to client dissatisfaction. The main problem is that if there are no matches, e.g if no buyers offer to match the selling trader’s asking price, there is no trade.


Learn about Impermanent Loss, a crucial concept in DeFi liquidity pools, and how to navigate and leverage it. Basically, anyone can start an LP on Uniswap, the exchange fee is fixed at 0.3%. This is the most popular and easiest to use the platform in the LP segment, and maybe even all of DeFi.

what are liquidity pools in crypto

In this article, we will look at what a crypto liquidity pool is and its role in DeFi networks. Balancer allows for the creation of liquidity pools with up to eight assets with adjustable weights, providing more flexibility than Uniswap. The procedure for accessing liquidity pools usually works differently on every platform. Some of them are user-friendly and interactive to make the experience as simple as possible, whereas others are more sophisticated and require additional knowledge.

Anyone Can Provide and Benefit From It

In this case, the lender would not communicate with the borrower, but this transaction will happen between the lender and the smart contract. Lending platforms are a simple decentralized lending and borrowing market. In the case of Single asset liquidity pools, a pool consists of one asset only.

Simple Ledger Protocol (SLP) is a token system that works on top of Bitcoin Cash. Sign up for free online courses covering the most important core topics in the crypto universe and earn your on-chain certificate – demonstrating your new knowledge of major Web3 topics. Liquidity pools operate in a competitive environment, and attracting liquidity is a tough game when investors constantly chase high yields elsewhere and take the liquidity.


Uniswap is a DEX that makes it easy for anyone to exchange ERC-20 tokens for a 0.3% fee. So, if you contribute $10,000 to a liquidity pool with $100,000 in total, you will receive a token representing 10% of the pool. You can redeem the token for a 10% share of the trading fees generated by providing liquidity to that specific ERC-20 token. Liquidity pools enable users to buy and sell crypto on decentralized exchanges and other DeFi platforms without the need for centralized market makers. It’s important to note that while LP tokens have the potential to earn returns, they also expose the holder to certain risks.

In short, it’s a loss in dollar value compared to HODLing when you’re providing liquidity to an AMM. Another, even more cutting-edge use of liquidity pools is for tranching. It’s a concept borrowed from traditional finance that involves dividing up financial products based on their risks and returns. As you’d expect, these products allow LPs to select customized risk and return profiles. Distributing new tokens in the hands of the right people is a very difficult problem for crypto projects. Basically, the tokens are distributed algorithmically to users who put their tokens into a liquidity pool.

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It refers to the temporary loss of value that occurs when a user provides liquidity to a decentralised exchange (DEX) or yield-farming protocol. This loss is termed ‘impermanent’, as it is only realised if the user withdraws the assets from the pool. The basic idea of connecting different exchanges with the ICTE liquidity pool focuses on reducing issues of security, custody, and latency. At the same time, ICTE offers the desired liquidity to all stakeholders and users on the platform. All exchanges on the ICTE platform run independently, albeit as a part of the worldwide ICTE Alpha server architecture.

  • Exchanges have been caught engaging in price manipulation, insider trading, wash trading, as well as manipulating their trade orders.
  • It refers to the temporary loss of value that occurs when a user provides liquidity to a decentralised exchange (DEX) or yield-farming protocol.
  • HEX liquidity providers enjoy the same level of compliance along with zero gas fees.
  • The more the providers, the more stable the trading pair is, the more stable the price is, but also the portion of shared fees is smaller per provider.
  • Some liquidity pools for crypto get around this by creating governance tokens and viewing the pool as community-owned.

Liquidity pools offer an excellent way to earn passive income with crypto. The first step is selecting a good platform and selecting the best pools for stable and secure income. When an investor supplies liquidity to a pool, that individual makes money by allowing others to use that liquidity for transactions. The investor supplying the liquidity earns a percentage of every trade.


Suppose a buyer wants to buy 100 TK (tokens) from the liquidity pool so he needs to make a payment of 100 ETH in order to get the 100 TK. When a trader exchanges his tokens on Uniswap, he will give a fee to Uniswap, which is then distributed to the Liquidity Pool. For more information on Uniswap, you can read our Beginner’s guide to Uniswap. In exchange for providing liquidity, Uniswap would give LP Tokens (Liquidity Provider Tokens) to the Liquidity Provider. From the borrower’s perspective, a borrower would deposit collateral to receive a cToken and receive a loan against it. As you can see in the above image, the borrower would deposit ETH as collateral and receive DAI as a loan and cETH.

Liquidity pools facilitate speed, and convenience to the DeFi ecosystem like decentralized trading, lending, borrowing and other DeFi activities. Liquidity pools are the foundation of many decentralized exchanges (DEX), such as Uniswap and Pancakeswap. Liquidity pools are an innovation of the crypto industry, with no immediate equivalent in traditional finance. In addition to providing a lifeline to a DeFi protocol’s core activities, liquidity pools also serve as hotbeds for investors with an appetite for high risk and high reward.

Therefore, liquidity pools help these platforms operate smoothly at all times. Suppose that you contribute to a liquidity pool and receive a corresponding liquidity pool token. Then, when you exchange the liquidity token for the original tokens, the IRS might consider it another taxable sale. The IRS considers cryptocurrencies property, meaning they’re subject to capital gains taxes. While buying and selling Bitcoin is pretty straightforward, DeFi transactions and liquidity pools introduce more complexity.

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