3 Things Everyone Should Know about Liquidity Pools and their Benefits
Crypto Liquidity Pools are an indispensable part of the decentralized finance (DeFi) ecosystem. Tokens or digital assets stored in a smart contract are collected in these pools, enabling users to buy, sell, lend and borrow crypto assets on exchanges and other DeFi platforms. This article will walk you through the two key points about liquidity pools and the benefits you can expect from them!
Liquidity pools are multifunctional
First and foremost, liquidity pools accept different types of digital assets. It is a mechanism by which users can pool their assets in a platform’s smart contract to provide asset liquidity for traders to swap between currencies, lend and also borrow. An article from Bitcoin.com stated that the Total Value Locked in DeFi applications had risen to $256 Billion recorded on December 2, 2021.
Second, liquidity pools enable most of the liquidity providers to earn trading fees and rewards from the exchanges in which they pool tokens. When an investor deposits his assets in the liquidity pool, the investor then called as liquidity provider can usually be rewarded with liquidity provider (LP) tokens. In such circumstances, investors are capable of earning a yield from his deposit. The yield involves the rewards from the blockchain network and transaction fees.
In summary, as liquidity pools give investors the opportunities to deposit their assets, exchange and receive various tokens as rewards, investors are able to diversify their investment portfolio.
Liquidity Pools provide speed & convenience to financial systems
Regarded as a pot of cryptocurrency assets locked in, liquidity pools make the financial system advanced with its speed and convenience. In fact, there are multiple businesses which are cash-strapped and seeking ways to get funding quicker without depending on a third party or central institutions. Statistics show SMBs’ demands to borrow exceed the capacity that banks are able to lend and that many banks have set new low points in total lending at a time when SMBs find it hard to obtain reasonably priced credit. The emergence of DeFi liquidity pools might be the solution to the current financial issues of such SMBs. By connecting their crypto with the pools where digital assets are stored within a smart contract, corporations then can use the pools for exchanges, loans, and other applications. For example, some businesses use payment companies like BitPesa in Africa, Tranglo in ASEAN and the major DeFi exchanges to either make direct payments or convert payment amounts to USD-backed stablecoin for cross-border remittance.
Liquidity pools target at solving the problem of illiquid market
By stimulating users to provide liquidity for a share of trading fees, liquidity pools can resolve the market illiquidity. Liquidity pools do not require sellers and buyers matching, meaning they do not need to trade their two assets for a given price, which allows trades to happen with limited slippage even for the most illiquid trading pairs.
A trade is successfully conducted when the buyer and seller agree on a final price. However, there are times when failed negotiations occur. In such circumstances, the absence of liquidity can affect these trades, but they are often fixed by market makers. The problem with market makers is that depending on them constantly produces unprofessionally slow and often pricey transactions. Liquidity pools fix this issue through automated trading, solving for illiquidity without the need for an order book.
DeFi liquidity pools give users, the DeFi ecosystem and financial system various benefits. Not only are users allowed to deposit their assets but they are also able to earn passive incomes from yields produced from the liquidity pools. Moreover, such pools can also be taken into consideration when corporations are seeking ways to lend, borrow or exchange immediately. Millions of corporations all around the world are calling out for new funding avenues. Let’s bring them through the door!
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Disclaimer: The information herein is for educational purposes only and should not be considered financial, investment, or trading advice. Please conduct your own research and due diligence before making investment decisions. You understand that you are using the Information provided at your own risk.