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32A Look at Liquidity Pools - The Funds That Keep DeFi Running

Crypto Weekly

A Look at Liquidity Pools - The Funds That Keep DeFi Running

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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.

Decentralized 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.

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

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available pools. The Balancer liquidity pool allows up to eight tokens. There is an easier way, however. In 2020, Zapper invented the concept of zapping into a liquidity pool, adding liquidity in one transaction. Simply connect your wallet at Zapper.fi. On the "pools" page, you can see all the liquidity pools available for zapping in and out. You can add liquidity to the pool with any asset you have. Zapper splits the assets into equal shares of the relevant pair. That eliminates the need for two different deals! There aren't all liquidity pools on DeFi, so Zapper only lists the biggest liquidity pools.

Liquidity Pools and the Future

trade. A pool with so few tokens locked up results in higher slippages when tokens are changed through a swap or any other activity. Liquid pools mean traders will experience little slippage. High slippage isn't the worst outcome. If a given trading pair doesn't have enough liquidity (e.g., ETH to COMP) on all protocols, then users will be unable to sell their tokens. The same thing happens with rug pulls, but it can also happen naturally if the market is not liquid enough.

Does DeFi have enough liquidity?

Typically, liquidity in DeFi is measured as "total value locked," which measures how much crypto is entrusted to protocols. A metric site called DeFi Llama estimates that the TVL for DeFi, as a whole, is $222 billion as of April 2022. DeFi's fast growth is also partly reflected in TVL: only $1 billion was recorded in early 2020 for Ethereum-based protocols.

What are the benefits of pool liquidity?

This can be profitable for investors. Token rewards provide incentives to liquidity providers. A crypto investment strategy called yield farming has been developed as a result of this incentive structure. Moving assets between different protocols can help users take advantage of yields before they dry up. The majority of liquidity pools also offer LP tokens, a sort of receipt, which can be exchanged for rewards from the pool based on how much liquidity was provided. To enhance yields, LP tokens may also be staked on other protocols. However, there are risks involved. Impermanent losses can occur when tokens in a liquidity pool (like ETH and USDT split 50:50) become unbalanced as a result of significant price changes. You could lose the money you invested in such a case.

What can be done to add liquidity?

There are two ways to add liquidity. If you already own ETH and USDC, which you can swap on a decentralized exchange, you can add funds directly to a liquidity pool, such as SushiSwap's ETH/USDC liquidity pool.

DeFi activities are usually two-sided - you exchange ETH for USDC, you borrow DAI against ETH, and so on. Therefore, you need equal tokens to trade, borrow, and conduct most other DeFi activities.

In order to maintain a balanced pair, most protocols require liquidity providers to pledge 50/50 of two crypto assets to Investors continually chase high yields elsewhere and take liquidity from liquidity pools in a competitive environment. An analysis by Nansen, a blockchain analytics platform, found that 42% of yield farmers who provide liquidity to a pool on launch day eventually withdraw from the pool. By the third day, 70% had left the pool.

In an attempt to combat "mercenary capital," OlympusDAO has experimented with "protocol-owned liquidity." Instead of setting up a liquidity pool, the protocol lets users sell their crypto into its treasury in exchange for its discounted protocol token, OHM. OHM can be staked for high yields. However, the model has been hit with a similar issue-investors who just want to sell their tokens and leave for other opportunities, which diminishes confidence in the protocol's sustainability.

Until DeFi solves the transactional nature of liquidity, there isn't much change on the horizon for liquidity pools.

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A Collection of NFT Tokens on the Cardano Blockchain Expand Snoop Dogg's Crypto Investment Footprint

Snoop Dogg is going back to expanding his crypto footprint. The collection is being launched on Cardano's blockchain this time, in partnership with Clay Nation. The Clay Nation collection is a collection of 10,000 digital clay characters. The collection is currently sold out, but the tokens sell on the secondary market.

Clay Nation tweeted about their tie-up with Snoop Dogg, whose real name is Calvin Broadus, and crypto investor Champ Medici. The tie-up will feature collectibles, unreleased music, and plots of Clay Nation land. Medici and Charles Hoskinson shared a Twitter space with Snoop last week, courtesy of Clay Nation.

Hoskinson suggested collaborating with Snoop Dogg on a guide for getting involved in crypto during the conversation. “Putting together a visual piece on 'how to' from both your and my perspectives, you know – you from your angle on how you got involved, and I from mine, then we'll take care of the whole planet," the musician said.

This year, he has invested in several NFT and crypto projects. The fact that Snoop Dogg is the first celebrity to switch from Ethereum to Cardano is causing a lot of hype. GlobalBlock analyst Marcus Sotiriou, who told the world last week that NFTs are all about brands and identities, said last week that Snoop Dogg recently made a music video entirely inside the Sandbox Metaverse. Snoop Dogg invested in social media platform Reddit as well as retail trading platform Robinhood.

Of his other notable investments, Klarna, a Swedish payments company, and previously invested in Moon Pay, a company that lets users purchase crypto easily with a credit card and a bank transfer.

In addition, he is one of thirty-seven investors who have invested in Yuga Labs, the team behind Bored Ape Yacht Club, according to Crunchbase data.

It is noteworthy that Snoop Dogg is one of the first celebrities involved in digital assets to venture beyond Ethereum's blockchain. Ethereum may be the most dominant platform for NFTs at the moment, but with Solana and Cardano making advances and lowering fees, this hegemony could be challenged.

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