Ok, lets be real, some of the informative articles and educational based content can be an information overload. I’m tired of reading the same content recycled with the same confusing babble.
If I knew what any of the crap meant of what I was reading, then I wouldn’t be scrolling online looking for an answer. (Insert fist flailing followed by the low audible sigh).
If you can relate to anything I’ve said so far, “Oh, well Hello, how you doing? I’m Maria, and I like straightforward answers that allow me to fluff on my own terms, intelligence permitting”.
It’s probably worth mentioning, that everything here is relative to the Cardano Blockchain.
I’m not going to pretend to know or even care about the differences on other blockchains. I’m not trying to hurt myself here by learning too much at one time.
Let’s see if my hours of perusing the internet can be reduced to a more simplified approach to understanding what a crypto liquidity pool is, and why anyone should or would care.
To make this a more engaging read lets apply real life scenarios to blockchain jargon.
Those of you that need more cerebral stimulation, hang on, I’ll fire off those cortexes for you too.
A crypto liquidity pool is a collection of crypto currencies or tokens that are locked by a smart contract. The keyword here is liquidity, which means turning things into assets or cash quickly.
Liquidity pools facilitate trades between assets on decentralized exchanges to allow for a more balanced process of trading, buying, and selling.
The rate at which you can retrieve your liquidity is determined by the demand for it. So, if you have a healthy pool with a good supply and demand then yay!
But if you have a pool that has higher supply and little demand, then you’re house rich and cash poor.
The pool is kinda like that exchange machine we all used at an arcade.
Put in $1.00 get 4 tokens and you get to play games for a chance to win tickets. The crypto lingo equivalent would be that the USD is actually ADA and the tokens are $NFTC, the native token for NFT Creative.
(If you haven’t heard of $NFTC, don’t worry, we’ve only just met)
Back to the vending machine thingy. Have you ever stopped to consider who put the tokens and the cash inside the machine? Where does the money go that’s fed into the machine? What happens when the money is taken out?
Great question. Let’s find out.
In order to create market conditions, you need someone to create a market. This is the essential element of a Defi ecosystem. Liquidity pools remove a lot of risks that centralized exchanges have; speed, confidentiality, security and profit to name a few.
When individuals add or contribute to the pool, they become LP’s ~ Liquidity Providers. So, to form a market LP’s combine equal values of 2 tokens ADA + $NFTC in a pool. In exchange for contributing into the pool, individuals who add to Liquidity earn from trading fees based on the percentage of the liquidity pool they own.
Wow that sounded like gibberish. ADA+$NFTC = LP’S.
LP’s = the % total of liquidity pool owned based on the total value of the pool.
For every transaction going in or out of the pool, the LP’s earn a % of the trading fees.
Providing liquidity only earns you fees from transactions using the assets that you contribute to the pool. So, if the pool has a 0.3% fee structure and you own 1% of the pool by value, you earn 0.003% of every trade.
Back to the vending token machine exchange, whatever I called it earlier. Inside that machine lives both, ADA + $NFTC. For the exchange between the 2 tokens to narrow, the total volume and value of the pool needs to grow, while still providing enough liquidity to allow for exchanges to occur. The best kind of liquidity pools should have good daily volume and large reserves that can handle market fluctuations.
Within a liquidity pool, the liquidity going out must stay equal. During extreme market fluctuations, a risk of impermanent loss is created. Ok, let’s stop here for a second. That term impermanent loss, like seriously, can we sound anymore foreboding? Eww.
The term impermanent loss to put it in simple terms is this. It’s a price gap from where you started to where you ended. This is when the price of the assets you deposit into a liquidity pool decreases. Again, during extreme market fluctuations the risk of impermanent loss is greater. When this happens, the liquidity going out must stay equal to maintain balance. Yes, I know I’m repeating myself, but it’s important.
Investors might end up with more of the crypto and less of the stable coin in a nutshell. This is not uncommon in smaller pools which are more susceptible to fluctuations in the market, which basically means that the value of your tokens decreases. Remember that arcade vending machine from earlier. During impermanent loss you might get 3 tokens to $1.00 or even less.
The reason it is impermanent is because you only notice it when you withdraw from the pool. It’s the value differential between the two currencies placed into the pool when you withdraw versus what you would have received had you kept the coins in your wallet.
If a LP removes all its cryoto before the value has increased or the token has stabilized, the loss becomes permanent. (Insert that doom sound da da da) Obviously the loss is permanent. Seriously, who comes up with these terms? Anyway, if you withdraw at a loss, then duh you don’t make a profit.
In any other situation, liquidity pools are still considered safe and profitable. Less volatile pools with slow stable growth are less likely to face a loss.
It’s important to use risk management strategies and facilitate a means to maintain a stable price. In order to achieve the ultimate goals, it’s always encouraged that token holders provide liquidity to pools. But wait, there’s more.
The more people that use the pool the greater the need to supply the pool becomes.
Hi again, it’s me, back with some wonderful examples to showcase how NFT Creative is adding to the $NFTC Liquidity Pool to allow for a stable growth. All ADA earned from using the official $NFTC Vendor goes directly into the liquidity pool.
Yes, we actually have our own $NFTC Vending Machine!
Let’s not forget the percentage of royalties received from mints on secondary market that are added to the liquidity pool. Additionally, all original NFT Creative projects all have a Royalty percent pledge going to the liquidity pool. Not to mention royalties received from other projects that have pledged a % of their secondary profits that are all added to the liquidity pool.