What is a Liquidity Pool and how You can Benefit from one
If you are a crypto enthusiast, you may have noticed the increasing popularity of liquidity pool exchanges. All markets - stock, forex, and cryptocurrency- face the problem of inadequate liquidity. Liquidity pools enable DeFi exchanges to maintain a constant level of liquidity.
A trade sets off only when a buyer meets a seller and they can both agree on the terms and conditions. Even if the buyer has the required money with him, we postpone the trade till the seller fixes a price. Trades may thus take longer than expected. Promising projects are shelved because of the delay in investment on DeFi platforms. This hinders the smooth functioning of the market and contributes to its inefficiency.
Liquidity pooling offers an excellent solution for this problem in cryptocurrency markets.
What is a liquidity pool?
Liquidity pool, as the name shows, is a pool of crypto tokens to enhance liquidity in a market. Liquidity is the ability of the market to convert an asset into another without affecting the market price.
Liquidity pooling facilitates liquidity and trading by locking the tokens in a smart contract. This way, even a newly launched venture which hasn’t yet developed a large user base can motivate investors to hold their tokens. Since this is a non-speculative method of increasing liquidity, it rules out the possibility of volatility. Some of the most popular liquidity pool providers are Uniswap, SushiSwap, Kyber Networks, and KingSwap.
Why use liquidity pools?
There are two popular types of exchanges in the DeFi space namely, order book exchanges and liquidity pool exchanges. Order Book Exchanges like 0x and Radar Relay depend on a bid/ask system to complete trades. Here, if you want to sell your asset, your order is first routed to an order book. The matching engine on the exchange will match your sales order with a purchase order of the same price. Now, this is an excellent system as long as there is adequate liquidity in the market.
However, the volatile nature of cryptocurrencies makes it difficult to maintain liquidity. The lack of trading volume also adds to the trouble. In case a large trade of a particular token is executed, the price of the token will witness a temporary swing. Liquidity pooling is considered an impressive innovation in the time of DeFi advent for this reason.
Tokens no longer have to depend on trade volume for liquidity as the fund is readily available. Liquidity pools like Uniswap source DeFi tokens from traders through smart contracts and make them available to those in need facilitating the smooth functioning of the market. These smart contracts essentially bridge the gap between sellers and buyers and give true meaning to DeFi platforms.
Traders are guaranteed liquidity at all price levels and buy and sell orders are matched automatically based on pre-defined parameters. As long as we fund the liquidity pool with adequate assets, liquidity remains constant. However, if the liquidity pool largely depends on a few traders for assets, the pool could lose sustainability when they pull out their funds.
How do liquidity pools help users?
Apart from providing liquidity at all price levels to the market, here are some of the other benefits offered by liquidity pooling:
1. Open to all
One feature that distinguish liquidity pool exchanges is their universal accessibility. There are no listing fees, KYC, or other geographical or jurisdictional barriers, common to centralized exchanges and certain DeFi platforms, that prevent you from being a part of decentralized liquidity pool exchanges.
If you have a smart device and access to the internet, you can become an investor any time you wish to and create a new exchange pair for any token listed on the platform. If you wish to contribute liquidity to the platform, all you need to do is deposit the equivalent value of both the DeFi tokens.
For example, if you want to add liquidity worth $500 to an ETH/CRO pool, you need to deposit $500 ETH and $500 CRO to the exchange. In return, you will get the native DeFi tokens of the liquidity pool exchange that clearly represent your share in the pool. You can withdraw these DeFi tokens any time you want to. However, when someone places a trade, a low trading fee is charged on the asset which is then added to the smart contract and eventually to the pool on completion of the trade.
2. Relatively lower gas fees
Simple, minimalist smart contract designs allow for smaller gas fees. Many DeFi platforms today have reduced their gas fees through the efficient calculation of price and distribution of fees within the pool. Uniswap, one pioneer in liquidity pool exchanges, charges 0.3% as trading fees. However, the latest forks of Uniswap have proven that this could further be lowered. For example, KingSwap charges a mere 0.25% as trading fees by smoothing out the friction between transactions.
3. Passive market making
Order book exchanges demand your time and focus while making a move. As the asset prices fluctuate with no warning, you need to closely follow the charts and rat your brains out constantly adjusting your bids and asks. Only if you are a professional adept in trading strategies, will you yield a profit on these DeFi platforms? However, liquidity pooling relieves you of the task to aggregate information from the exchanges and determine the price of assets. Rather, you just have to deposit your DeFi tokens or assets into the pool. The smart contract will take care of the pricing. Instead of a matching engine, it will also help you complete your buy/sell orders.
Take your dive into liquidity pools with KingSwap
Liquidity pools increase liquidity between sellers and buyers, minimizing volatility, the prime factor that deters people from crypto, to a great extent. KingSwap is one of the liquidity pool DEXs to rise to prominence in recent times. A fork of the Uniswap protocol, our venture has stood out for offering off-ramp fiat currency, converting solutions with better user experience and convenience. The core design of Uniswap is altered for the full-fledged adoption of decentralized liquidity pools. KingSwap is sure to play an important role in the gradual move towards the mass adoption of cryptocurrencies. Whether you are a newbie crypto enthusiast or a seasoned trader, leverage the full potential of liquidity pooling with KingSwap.