Liquidity pools enable you to buy or sell an asset for another asset on a crypto-currency exchange. Think of each liquidity pool as a mini market within the larger market, ensuring reliability and expediency when you trade two different tokens.
Liquidity pools are important in decentralized finance (DeFi) — particularly decentralized exchanges (DEX). Because Sifchain is the world’s first omni-chain DEX, this technology is fundamental to our vision. We use something called a Continuous Liquidity Pool (CLP).
Centralized exchanges (e.g. Coinbase, New York Stock Exchange) use order books: marketplaces where buyers and sellers come together, respectively trying to buy at the lowest possible price and sell at the highest possible price.
Sifchain uses a hybrid model with both an order book and CLPs.
Frequently Asked Questions
How does it work?
Sifchain derives its internal asset price from CLPs. Our native token, Rowan (RWN), is the settlement token. Traders must directly or indirectly purchase Rowan in order to execute trades against CLPs. For example, the USDC:BTC internal price is calculated using the USDC:RWN and RWN:BTC CLPs.
How are CLPs created?
Anyone can create a CLP by pooling Rowan and a new token into a pool initialization transaction. The price of the new token is set based on the amount of Rowan pooled. Sifchain enforces a minimum CLP size but multiple depositors can contribute to the creation of a single CLP.
What are the benefits?
Liquidity pools are fundamental to decentralized crypto-currency trading platforms including Uniswap, Sushiswap, Balancer, Mooniswap, MCDEX, Thorchain, Perpetual Protocol, Curve, Bancor, and others. Even Binance created a liquidity pool swap program on its centralized exchange because the returns are so lucrative.
Sifchain enables liquidity providers to add liquidity into pools where they can earn income without constraints endemic to other exchanges. Liquidity providers can deposit any token Sifchain supports to the appropriate pool. They can add liquidity asymmetrically, meaning they can add only Rowan or only TKN for any token.
For margin trading, traders are able to borrow liquidity from a CLP. This allows them to “long” cryptocurrency on margin, leveraging the value of the cryptocurrency they already own to increase their investment size. Thus, traders can potentially magnify returns, assuming the value of the investment rises. Margin trading provides a new revenue source for liquidity providers (lending) and increases revenue from trading fees.
Another key benefit is the fee structure, which is responsive to the demand for liquidity by market-takers. In short, impatient traders are penalized. This quality is important because it allows time for information to be propagated to all participants rather than giving the privileged few an edge.
Why not use oracles to determine asset prices?
Price oracles are centralized points of failure, relying on incomplete and asymmetric information, making exploitation easy in relatively illiquid DeFi markets.
We use a combination of CLPs and automated market making (AMM) to ensure that prices align with what oracles report.
Who are CLPs for?
- Traders/Swappers — They want to earn a profit by buying and selling cryptocurrencies on a deployment of Sifchain with mainnet Sifchain and external chain tokens.
- Arbitrageurs — They are a type of trader or swapper who want to earn a profit by trading or swapping on Sifchain and an external chain simultaneously in such a way as to profit from differences in prices on the same assets on different exchanges.
- Liquidity Providers — They want to earn swap fees on users swapping Rowan and pegged Ethereum assets.
Reference our article Sifchain Technical Introduction: Advantages of an Asymmetric Liquidity Pool to learn more.