The decentralized financial economy takes place on something known as the “liquidity”, which refers to the funds provided by users of the protocol to keep their engines to turn. These liquidity pools are the vital element of DEFI applications, allowing users to exchange tokens, lend and borrow funds, etc.
At the time of writing, there is currently more than $ 100 billion of value locked in hundreds of DEFI liquidity pools. The vast majority of these pools are what feeds token on decentralized exchange platforms. They are created when users lock two types of crypto in an intelligent contract, providing the capital necessary for others to buy and sell these assets.
Why do DEX need liquidity?
If a pair of token on a decentralized exchange has low liquidity, it causes a problem called “shift”, where the merchant will see a notable difference between the price of the expected token before making a business and the price of real token after execution.
This shift occurs when there is not enough liquidity in the pool to treat the order of the user at the same time. The absence of liquidity means that the order will be treated at various stages, and at each stage, the balance of the tokens in the swimming pool changes, modifying their price. But if a swimming pool has a lot of liquidity, the shift is not noticeable. Instead, its users will be able to buy and sell these tokens quickly without significant price impact. These pools are therefore essential for the smooth operations of the DEX platforms, which explains why they provide solid incentives for people to deposit liquidity.
Providing cash can be a lucrative business for investors, as most DEX platforms offer strong incentives to depositors. Essentially, anyone who deposits liquidity in a pool obtains a proportional part of the awards which come from the costs applied to each profession on the platform. The real costs and the incentives offered vary from one platform to another.
In addition, investors will generally receive “liquidity supplier tokens” or LP tokens, which are reception tokens that represent their share of liquidity pool. These can be redirected to other DEFI protocols to obtain an additional return.
How to provide liquidity?
To start, you will have to identify the platform on which you wish to deposit funds. Some of the most popular DEX include UNISWAP, SUDHISWAP, Curve, Balancer and Pancakeswap. Your choice really depends on what suits you best, taking into account your familiarity with the platform, its ease of use, pairs of token it offers, announced yield, etc.
For strangers, there are various websites, especially Coinmarketcap And Poolwhich provides tools to compare the rewards offered by various liquidity pools on Dex platforms.
Once you have identified a platform, you will need to connect your cryptographic wallet to the DEX. Popular portfolios such as Metamask, the trusted wallet and the exodus are recommended, as these are compatible with most of the main DEX platforms. Then, you simply work on the list of liquidity pools on this Dex and check the awards offered, while taking into account the risks associated with each token.
As a general rule, incentives are often much higher with more obscure tokens, but deposit in these pools also has a higher risk.
In most cases, you will have to buy an equal amount of the two tokens so that you can deposit funds on both sides of the pool to help maintain your balance. For example, if you want to put $ 500 in the eth / USDT liquidity pool of sushiwap, you will need to buy $ 250 ETH and $ 250 USDT.
Once you have identified the swimming pool you want to join and have the necessary funds, the next step is to move forward and make the deposit. According to the DEX, you may need to configure a proxy contract or sign a transaction message before you can do so. This is generally a unique action, and all you have to do is click on “Confirm” when invited to do so by your wallet. This step can cause gas costs.
Make sure you check to triple the portfolio address where you send the funds to make sure it is a portfolio belonging to Dex. Because most cryptographic transactions are irreversible, you cannot afford to make a mistake. Once the transaction has been confirmed, you will receive LP tokens for this specific pool.
Most DEX will automatically deposit all the transaction costs billed to traders in their respective liquidity pools, so that liquidity suppliers only earn their rewards once they bought their original deposit.
How to maximize liquidity pool yields?
The emergence of liquidity pools has led to the rise of “yield agriculture”, where users constantly move their funds in different pools, to continue the highest possible yields. However, it has become increasingly difficult to maximize performance agriculture strategies due to the constant expansion complexity of the DEFI landscape.
Protocols constantly adjust their incentives in real time, and there are literally hundreds of Dex and thousands of liquidity swimming pools. It is therefore simply not possible for humans to stay informed of everything and to ensure that their capital is always in the most profitable swimming pools. We do not have the cognitive ability to do it, and we must also sleep!
Enter AI agents, who provide an intelligent solution to this problem. AI has the advantage of never having to fall asleep, and it can permanently monitor hundreds of protocols through dozens of blockchains to identify the most profitable liquidity offering opportunities.
For example, Giza Protocol IA agent Arma is an autonomous performance optimization agent designed to help investors maximize their profits when providing liquidity to stablecoin pools on networks such as the base and the fashion network.
It works by monitoring the DEFI protocols such as Aave, Morpho, Moonwell and Compound, keeping constant monitoring on the fluctuating incentives that these platforms provide. Its objective is to ensure that the funds of its users always gain maximum profit possible. If user funds are currently being deposited in the USDC / ETH pool on Aave, and suddenly sees that the compound offers a better rate in its USDC / ARB pool, it can immediately remove these funds from the first pool and deposit them in the second to ensure that they benefit from this higher rate.
Even better, Arma is not content to look at the awards offered, but it also represents the costs involved to move the user's funds. If additional gas costs mean that the user will no longer make profit, exchange. Giza says that Arma can be an incredibly effective tool, with one of her studies showing that he could generate an 83% increase in yield compared to the maintenance of a static position in a single liquidity pool. No wonder, this Arma is already boasting more than $ 1.16 million in user funds under management.
Are there risks?
Providing liquidity in DEFI can be extremely profitable, but users should be wary not to do so always. Although you are guaranteed to earn a share of the costs that everyone performs a job using this pool, other factors may have an impact on your profitability.
The greatest risk associated with liquidity pools is a phenomenon called “impermanent loss”, which refers to the time when the ratio of tokens in a swimming pool is unbalanced due to substantial price changes in underlying assets. If this happens, the value of user funds could block considerably. The threat of impermanent loss should not be ignored, a bench study in 2021, noting that more than half of all liquidity suppliers on Uniswap lost money In dollars, even if they collect negotiation costs.
Most experts say that bull markets have the best opportunity for liquidity suppliers, because commercial activity tends to increase considerably, and the price of underlying assets can also increase. This helps to counter the effects of impermanent loss. But in the bear markets, the reverse is true.
The vital language of Defi
Because liquidity pools are still a relatively new concept, they have attracted almost as much skepticism as speculation. It is just to say that investors can generate a significant passive passive income from the supply of liquidity to DEFI exchanges, but this can also be very risky. In addition to impermanent losses, there is the risk of firing carpets and failures of intelligent contracts, which can lead investors to lose all their funds.
Nevertheless, liquidity is the vital element of DEFI, absolutely critical for the protocols to work, and as long as DEFI exists, there will always be incentives offered to people wishing to provide it. In addition, protocols DEFI constantly innovate and find more creative mechanisms to mitigate the risk of impermanent loss.
