OP 15 January, 2024 - 07:57 PM
Instead of an order book, most decentralized exchanges (DEX) use an automated market maker (AMM) algorithm, so they require liquidity providers (LPs) to offer a functional trading ecosystem.
The LP needs to provide liquidity for a trading pair, meaning two different tokens are required, which he must deposit into a pool. Its funds are then locked by a smart contract and used by other participants for exchange or lending transactions.
In return, the liquidity provider receives a special token that will reflect his share in the pool. He will receive remuneration proportional to this share.
Each platform has different terms and conditions on which the level of income may depend. Some distribute rewards based on the amount of liquidity provided, while others use more complex algorithms.
Suppose we invest in the CAKE-BNB pool. To do this, we need to deposit two tokens there (CAKE and BNB) for the same amount.
For example, 1 CAKE is valued at $1 and 1 BNB is valued at $100. To invest $10,000 in the pool, we need to add 5,000 CAKE and 50 BNB to the pool.
If the amount of investment in the pool increases, our share will decrease. The reverse is true when liquidity decreases. Therefore, less popular pools offer much more attractive conditions. However, as profitability grows, so do risks.
The LP needs to provide liquidity for a trading pair, meaning two different tokens are required, which he must deposit into a pool. Its funds are then locked by a smart contract and used by other participants for exchange or lending transactions.
In return, the liquidity provider receives a special token that will reflect his share in the pool. He will receive remuneration proportional to this share.
Each platform has different terms and conditions on which the level of income may depend. Some distribute rewards based on the amount of liquidity provided, while others use more complex algorithms.
Suppose we invest in the CAKE-BNB pool. To do this, we need to deposit two tokens there (CAKE and BNB) for the same amount.
For example, 1 CAKE is valued at $1 and 1 BNB is valued at $100. To invest $10,000 in the pool, we need to add 5,000 CAKE and 50 BNB to the pool.
If the amount of investment in the pool increases, our share will decrease. The reverse is true when liquidity decreases. Therefore, less popular pools offer much more attractive conditions. However, as profitability grows, so do risks.