The cryptocurrency sector capitalized on the dynamic of “fewer buyers and more sellers: cheap pricing.” Back in the day, when there were more buyers than sellers, prices were high.
However, due to the industry’s crypto liquidity provider, prices are now dependent on AMM (Automated Market Maker) employing a mathematical algorithm.
AMMs measure liquidity by how quickly an asset sells (liquidity suppliers – purchasers). A crypto liquidity provider is a person who engages in trading a certain currency.
Decentralized finance, or DeFi for short, is a type of finance that uses blockchain modern technologies, smart contracts, and decentralised applications (dApps) to provide payment systems such as lending, trading, and funding without the use of intermediaries and in an open and transparent manner.
DeFi has been around for a while, but it truly took off in the summer of 2020 – known as DeFi Summer – when loan and lending business Compound debuted the COMP governance token, which it utilised to reward its users through a process known as liquidity mining.
Such COMP-based payments significantly raised yields, enabled more complicated yield farming tactics, and let token holders to engage in governance.
We can enhance TVL with many other metrics of DeFi activity, such as the number of dApps, transfers, and total and operational wallet addresses.
Other indicators include decentralised exchange traffic, ongoing DeFi loans, stablecoin production, and even capital raising.
The proportion of ether trapped in smart contracts is one of our favoured KPIs. While this metric, like TVL, assesses what is secured in a protocol at any one time, it eliminates the price of ETH from the calculation, providing a more direct glimpse into activity.
A liquidity provider often provides market price direction, including accessible data on asset pricing (sales and transaction fees) and the benefits and drawbacks of keeping that asset. Are you interested in learning more?
Continue reading until the conclusion, and we will show you how to supply liquidity using real-world situations.
What Is a Liquidity Provider?
A cryptocurrency liquidity provider facilitates trades and financial activities for traders and other financial market players.
According to DeFi protocols, liquidity provisioning is described as acting as a mediator by frequently trading in and out of relatively short positions. Assets are kept in liquidity pools.
Farming Yield and Liquidity Provider
Decentralized exchangers in the Dex DeFi ecosystem reduce the need for a middleman by forming an investment pool.
The pool keeps the investor’s cash until the asset’s liquidity grows and it becomes a profitable deal. Yield farming is when a liquidity provider waits for the asset’s price to rise.
To put it another way, as a liquidity provider, you’ve planted the seeds and are now waiting for the harvest. Furthermore, you get a trading fee every time a trader buys or sells the asset you’ve pooled for.
Increased liquidity benefits everyone in the market. As a result, spreads and trading expenses are lowered. It affects the price stability of an asset by making it safer. More liquidity sources reduce losses, and most initiatives are frequently successful.
Read also : Algorithmic Cryptocurrency Trading
What is the Process of Becoming a Liquidity Provider?
Make sure you invest in a large liquidity pool to become a crypto liquidity provider. You can research asset price ranges using liquidity aggregator tools or programs and invest in a pair that provides attractive pricing.
Before being a market member, you must additionally sign a liquidity provider arrangement to become a Defi liquidity provider. This agreement is required since it certifies your involvement in different pools and venues.
If this is not apparent, continue reading, and we will elaborate more in the area following.
Once you’ve settled on a pair, you’ll need to take a few steps to become a liquidity provider.
Step 1: Select a Coin Pair
Go to the Uniswap website and select ‘pool’ rather than swap.’ Click ‘Add liquidity’ and then select a pair of token pools.
Step 2: Include Liquidity
After you’ve chosen your coins, it’s time to increase liquidity. You must specify the number of coins you wish to contribute.
If you put in.5 ETH, the DEX will immediately recommend a DAI 0.15 value. Anyone who trades the pair will now pay a little charge, which will be returned to you as a profit. You may also withdraw the coins at any moment.
Step 3: Purchase
After boosting liquidity, the final step is to make a purchase.
If you have a wallet linked, you can confirm the transaction by paying the amount.
It will only take a few seconds for confirmation, and you will be a participant in liquid provision before you know it.
When you successfully deposit coins for liquidity supply, the DEX will issue you Liquidity provider tokens (which are produced automatically) to represent your portion in the pool.
You must let the coin pair sit for an extended period before they begin to benefit. The combination of liquidity provision and yield farming is an excellent strategy to generate passive income. But are there any advantages to becoming a liquidity provider? Continue reading the following section.
What Do You Get When You Become A Liquidity Provider?
Liquidity for an asset is crucial for any DeFi market. You are increasing the potential of the virtual assets to provide liquidity.
Because of the liquidity you contributed, the asset will swiftly convert into profits over a specified period.
But, as a liquidity provider, what do you get in return? There are certain clear trading advantages that a liquidity provider receives.
Tokens of Limited Partnership
Liquidity tokens (LP tokens) are tokens issued by a DEX for the purpose of providing liquidity. The advantage of the liquid supply is that you may swap LP tokens between DeFi networks.
As a result, it benefits the ecosystem by enabling cross-protocol liquidity movement and opening doors for traders to transfer and stake these LP tokens on multiple DeFi platforms in order to continue collecting returns.
Consistent Passive Income
Each operation (trading charge) of their liquidity pool trades produces a profit for the liquidity provider.
If you join Uniswap as a DAI LP, you will get a 0.4 percent incentive fee for any DAI/ETH or ETH/DAI exchange you make on the platform.