Guide To Understanding What are Liquidity Pools in Crypto Means

liquidity pools in crypto
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Understanding what are Liquidity Pools in Crypto? If you are into cryptocurrency or Decentralized Finance ecosystem (Defi) you may have come across this crypto glossary a number of times. If you’re on this article right now, you are definitely looking for the meaning of Liquidity Pools and how they go about, and why it is needed in the Decentralized finance (Defi) ecosystem.

In this article, we will give you a detailed explanation of what Liquidity pools are, how they work, the importance of liquidity pools are so much more.

What are Liquidity Pools?

Liquidity Pools make it possible for crypto users to buy and sell crypto on decentralized exchanges like PancakeSwap, Binance DEX, Balancer, Uniswap, dYdX, Sushiswap, Raydium, MDEX, THORChain, Curve Finance, etc. For example, Karl has a few dollars and wants to get into Bitcoin, Karl goes to any of these to buy bitcoin and can also sell them.

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Much decentralized finance (Defi) platforms like the ones we have listed above use Automated Market Makers (AMMs) this makes it possible for digital assets like Bitcoin, Eth, ADA, etc. to be traded in a reflexive and permissionless way.

What are Liquidity Pools Safemoon?

Safemoon features a self-sustaining liquidity pool that sucks up tokens from transactions in the form of fees and adds them to Safemoon’s liquidity pool on PancakeSwap. This adds a solid price floor for the token. (via Coinmarketcap)

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 How do Liquidity Pools in Crypto work?

In most ways, a functional liquidity pool work in a way that motivates or rewards crypto liquidity providers eg MDEX, PancakeSwap, Binance DEX, etc. to stake their assets in a pool. With this, Liquidity pool providers earn trading fees and crypto rewards from the crypto exchanges upon which they pool tokens.

For example, If Karl supplies a pool with liquidity, the liquidity provider (LP) is rewarded with special tokens called LP tokens the amount of LP Tokens rewarded to the Liquidity Provider is measured in the magnitude of how much Liquidity they add to the pool. Simply put, a fractional fee is shared among the LP token holders.

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 In the eyes of the LP, the LP tokens earned holds value in their own rights and be made utilized in various ways through the Decentralized finance (Defi) ecosystem when the need arises.

What is the Importance of Liquidity Pools?

  • One of the merits of a liquidity pool is, it largely determines or influences how an asset’s price can move upwards or downwards. this has made it clear that a single transaction could make the price move in any direction thereby making the crypto market unpredictable.
  • Liquidity Pools have played an important part in the revolution of Defi. Liquidity Pools allow the exchange of an unlimited large number of digital assets like Bitcoin with any other supported assets in Decentralized finance space or ecosystem.

What are Liquidity Pools in Decentralized finance (Defi)

Let’s look at what Decentralized finance means is a blockchain-based form of finance that does not rely on the central finance intermediaries such as the exchanges, brokerages, or banks to offer traditional financial instruments, and instead utilizes smart contracts on the blockchain. (via Wikipedia)

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Recently, the Defi ecosystem has surpassed the $60 billion valuations making it an all the record valuations.

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Advantages of Liquidity Pools

  • There is assured liquidity at every price trade level. Due to constant liquidity, traders do not necessarily have to connect to other traders.
  • Lower gas fees
  • Anyone can become a liquidity provider and earn because liquidity pools do not require much from investors who want to provide liquidity pools.

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