30
BEGINNERS GUIDE Crypto Weekly
A Look at Liquidity Pools - The Funds That Keep DeFi Running Liquidity is the lifeblood of finance. The financial system cannot function without it. Liquidity pools are crucial to the smooth functioning of decentralized finance (DeFi). Decentralized finance falls apart in the absence of available funds.
D
ecentralized finance refers to financial services and products on the blockchain. The smart contract is a self-executing code that enables DeFi activities, such as lending, borrowing, and token exchange. Liquidity pools are contracts that allow users to lock crypto assets in so that they may be used by others. There are no direct counterparts in traditional finance for the liquidity pools of the crypto industry. Furthermore, liquidity pools serve as hotbeds for investors with a high appetite for risk and reward in addition to providing a lifeline for the core activities of DeFi protocols.
April 2022 | Volume 24
How do liquidity pools function? As soon as you look past the technical language, you will understand the logic behind liquidity pools. Cryptography is required for any economic activity to occur in DeFi. It is precisely liquidity pools that are set up to supply crypto, which is exactly what cryptocurrency needs. (On centralized exchanges, this role is fulfilled by order books and market markers.) A decentralized exchange's liquidity pool is what users rely on when they sell token A and buy token B. By buying B tokens, fewer B tokens will be in the pool, and the price of B
will increase. That's just supply and demand. The platform's users provide smart contracts containing locked crypto tokens through liquidity pools. As self-executing processes, they do not need intermediaries to function. These algorithms are supported by other pieces of code, such as automated market makers (AMMs), which use mathematical formulas to maintain liquidity pool balances.
When is low liquidity problematic? Slippage occurs when liquidity is low, resulting in a significant difference between the expected and actual price of a token
www.cryptoweeklymag.com
