♻️What are liquidity pools?
Liquidity pools are one of the basic ideas standing behind the DeFi system.
They are a kind of storage of funds locked on a smart contract and provided by users. These funds are used for swapping, depositing, savings and farming. If someone wants to buy tokens, the DeFi platform will use these pools supplies.
The size of the liquidity pool is measured in terms of TVL, the total value of assets locked in the liquidity pool. We can gauge the size of the pool of current trading pairs or the size of all DeFi market. The more TVL is, the more liquidity is added to the pool.
▶️ So, why do we need liquidity and what problems user can face while poor liquidity?
Imagine a traditional bank that keeps money, gets them from one user and lends them to another one. All it works due to structure, bureaucracy and people involved. The liquidity pool serves as a bank but on a DeFi field with a fully automatic process.
▶️ Liquidity pools are in general divided into trading pairs such as ETH-DAI, USDT-BNB and any other listed on exchanges.
There is no problem to buy or sell your ETH, USDT, CAKE, or other popular tokens that are listed on the majority of exchanges. Trading pairs on these tokens are supported by huge liquidity provided by DeFi users. But what will you do in case the token you want to buy or sell isn’t in a TOP-10 chart?
That’s why DeFi needs liquidity providers.
▶️ Liquidity providers are users who add liquidity to current trading pairs in a current pool and derive LP tokens and rewards after they have staked these tokens. This mechanic motivates users to keep their tokens in the liquidity pool as long as a user wants to get rewards and considers being a liquidity provider as a rational strategy. Other users get the opportunity to buy and sell cryptos easily without slippage.
That’s how yield farming appeared when users move assets around on different protocols to be rewarded before they dry up.
If the liquidity pool is poor it could be hard for users to sell their tokens because no one needs them. So when you are planning to trade a new token you need to check its TVL and be sure it won’t be a problem for you to find a buyer. Also, poor liquidity generates a high slippage when the real and expected transaction prices are very different. Low liquidity leads to high slippage because changes in the number of tokens in the pool due to exchanges or any other activity cause more imbalance when few tokens are locked in the pools.
What are the risks of liquidity pools?
✔️ First of all, you should be aware of the impermanent loss. It happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them.
✔️ While your funds are deposited into a liquidity pool a smart contract itself can be thought of as the custodian of those funds. If there is a bug or some kind of exploit your funds could be lost forever.
✔️ And be aware of projects where the team has permission to change the rules governing the pool.
▶️ MMPro team allows users to add liquidity to a set of different pools based on a pair of MMPro tokens and our partner’s tokens. Check out our pools with a high APR rewards. Learn more on MMPro Farming: https://farming.marketmaking.pro/
