Liquidity pools are basically large utensils of cryptocurrencies that many users contributed. These complexes allow direct trading between cryptocurrencies without relying on intermediaries such as banks or exchanges.
What are liquidity baths?
When you contribute to liquidity, you become a liquidity provider. This means that you deposit two types of cryptocurrencies in an equal value. For example, if the OrthC and USDC and ETH 1 group are valued at $ 2,800, you will need to deposit 1 ETH and 2800 USDC. Smart contract – automatic program – converts the assembly. It follows deposits and uses algorithms (such as UISWAP product formula ongoing) To control prices based on the balance of cryptocurrencies when trading occurs.
When someone trades – the ETH is suitable for USDC – the smart nodes automatically calculate the new price based on the remaining amounts in the complex. As a liquidity provider, rewards, such as trading fees, are earned to facilitate these deals.
In essence, liquidity gatherings simplify decentralized trading, while allowing shareholders to earn a negative income.
How liquidity gatherings work
Most liquidity pools work with a fixed product formula, represented by x x y = K, which guarantees a balanced percentage between cryptocurrencies in the complex. For example, imagine a rare of 50 ETH and 140,000 USDC, with ETH 1 $ 2800. The total value of the complex is $ 280,000, and K is calculated as follows:
50 eth x 140,000 USDC = 7,000,000
This fixed (K) remains unchanged regardless of deals, ensuring that the output of ETH and USDC are always equal to 7,000,000.
What happens when trade occurs
Suppose the trader is 1 ETH for USDC. The process is revealed as follows:
- ETH balance in the complex increases from 50 to 51.
- To keep the fixed K, the USDC balance is set to 51 x y_new = 7,000,000. The Y_NEW solution gives about 137,254.90 USDC.
- Initially, the complex holds 140,000 USDC. After trade, it keeps 137,254.90 USDC. The difference – 140,000 – 137,254.90 – Equality 2,745.10 USDC, which is the amount provided to merchants.
However, the trader does not receive a full amount of $ 2800 of USDC due to the slide – the change in the assembly rate when adding an additional ETH. In addition, fees are imposed (for example, 0.3 %). In this example, the drawings are:
2,745.10 USDC x 0.003 = 8.24 USDC
After deducting the fees, the trader receives about 2,736.86 USDC.
Over time, K can change if liquidity is added, removed or accumulated trading fees in the complex, which gradually increases its total value.
In short, liquidity pools use the fixed product formula to automatically balance the encrypted currencies during trading, with sliding and drawings that affect the specific amounts received by traders.
What are the risk of using liquidity baths?
Liquidity complexes provide advantages such as negative income and decentralized trade, but they come with some differentials, such as the risk of unstable loss of LPS and the slipping of merchants.
Other risks include smart weaknesses of contracts, fraud such as rug, market fluctuation, and manipulation by big players or robots. To reduce these risks to a minimum, users must choose well customized platforms and avoid very volatile or low -liquidity gatherings.
Danger for liquidity service providers
Below is a rapid collapse of the risks that each participant faces when dealing with liquidity pools.
The carpet pulls and penetrates
Liquidity pools depend on smart contracts (automatic symbol). If there is any error or weakness in the code, the infiltrators may steal the money. For example, in 2023, EULER Finance lost $ 200 million due to a flash loan attack that used a gap in its smart contract.
The carpet pull another threat. This is a fraud where the developers create fake liquidity bathrooms, attract deposits, then withdraw all money, and leave LPS with valuable codes.
Market fluctuation and billiard concentration
Surprising price movements can increase the inaccurate loss and make revenues unexpected, especially in the complexes of volatile assets. There is also a threat to focus: If one or a few of the adult service providers control most liquidity in a gathering, they can deal with prices or destabilize the gathering by suddenly withdrawing large sums.
Unnecessary loss
Inaccurate loss occurs when the price of symbols in the complex changes significantly after depositing them.
For example, if you deposit ETH and USDC in the collection and high price of ETH, traders may buy from the ETH from the group at a reduced price. As a result, you end up with more American cupboard (the distinctive lower value code) and less ETH.
It is called “Destermanent” because the loss can be reversed if prices return to their original levels. However, in volatile markets, the loss becomes permanent.
Merchant risks
Traders also face many problems when dealing with liquidity pools.
sliding
Slip occurs when the trade price changes between the time you put it and when it is implemented. For example: In low liquidity gatherings or in large deals, you may receive less symbols than expected because the distinctive symbol rate changes during your trade.
Front and sandwiches attacks:
And robots or malignant merchants can see your suspended treatment and put their own deals before or after that to take advantage of price changes. Example: The robot puts a trade in front of you to raise the price and the other after I lead it, which leaves you with the lowest favorable implementation prices.
Prices and liquidity limited:
Big deals can be artificially manipulated in symbolic prices in limited liquidity swimming pools, forcing ordinary traders to pay more than expected. Moreover, if there is not enough liquidity in a gathering, large trading may fail or suffer from a high slide.
What are the benefits of using liquidity pool?
Liquidity gatherings allow uncommon symbolic bodies without the need for third parties. They use advanced algorithms to discover effective prices and reliable liquidity, even for less popular symbols. This reduces slipping, making deals more predictable and costly effective. For liquidity service providers, these complexes provide negative income through commercial fees and bonuses such as the distinctive symbols of governance, while traders benefit from high liquidity and DEFI.
How safe is liquidity baths?
Safe liquidity pools such as smart contracts and the security measures they support. Its safety depends on the quality of the protocol, the extent of infrastructure review, and the underlying risk of basic assets.
Related questions
What is the difference between the circular loss and the slip?
Below is the main difference between the two:
- Inaccurate loss: This affects liquidity providers when the price of symbols deposited significantly changes compared to the deposit time.
- Slip: This affects merchants when there is a difference between the expected price and the price of trade implementation, and this is often due to the transformation of the distinctive symbol rates during the swap.
How is the fees distributed in the liquidity gathering?
Fees are shared from deals between liquidity providers based on their share of the assembly. When a trade occurs, symbolic fees are deducted and re -invested in the complex, which increases its total value.
For example:
- If you own 10 % of the complex, you will get 10 % of all the fees created.
- Some platforms may divide the fees differently – for example, 87 % to LPS, 12 % for the DAO cabinet, and 1 % for the developer program.
What is the difference between liquidity pools and traditional exchanges?
Traditional stock exchanges require the buyer and the seller to match the trade, which may lead to delay if there is no matching party.
On the other hand, liquidity pools maintain a reserve of symbols, allowing traders to switch the assets immediately with the pool reserves. This model is used by decentralized exchanges such as UISWAP, Pancakeswap and SUSHISWAP to ensure that trades can be carried out at any time without waiting.
