A Lesson On Liquidity Pools
A Guide On Providing Liquidity To Decentralized Exchanges
Over the last few weeks, I have been asked by several people to explain the process of providing liquidity on a decentralized exchange like Uniswap. In an effort to answer this question, I have put together a quick blog post that explains it all from a layman’s perspective. Providing liquidity is an excellent way to put your existing crypto to work, but it doesn’t come without risk. Read on to learn more.
What Is A Liquidity Pool?
Think of a liquidity pool as a big pot where people deposit cryptocurrencies for use in trades on a decentralized exchange (DEX). On a dex, instead of having buyers and sellers make trades directly with each other, trades instead happen against this pot of crypto assets.
For example, if you want to trade ETH for USDC on Uniswap, you’re not buying directly from another person. Instead, you’re trading against a pool of ETH and USDC that other people have deposited. This pool ensures that there’s always some amount of each cryptocurrency available for trade. Without liquidity pools, there wouldn’t be any assets for you to trade.
How Do Trades Work On A DEX?
When you place a trade on a DEX, you’re essentially interacting with a liquidity pool. Here’s a simple breakdown:
Depositing Funds: Users deposit pairs of crypto coins into a liquidity pool. For instance, if you add liquidity to an ETH/USDC pool, you’ll deposit both ETH and USDC into the pool.
Making a Trade: When you make a trade (say, you want to swap ETH for USDC), the DEX calculates the amount you’ll get based on the ratios of the assets in the ETH/USDC liquidity pool we talked about above. The more you trade, the more the balance of that pool changes, which affects future trades and prices. For example, let’s say there is a liquidity pool with 1000 in USDC and an equivalent amount of ETH. Someone buys $100 of ETH using USDC. Now, the pool has $1100 in USDC and only $900 in ETH. This will be reflected by a change in the price of ETH on that DEX.
Earning from Fees: As a liquidity provider, you earn a share of the transaction fees charged by the DEX. Each time a trade is executed, a small fee is collected, and a portion of this fee is distributed among all liquidity providers. The more liquidity you provide, the greater your share of the fees will be. On top of this, many DEX's incentivize liquidity pools by adding emissions of their own token, such as AERO.
Automated Market Makers (AMM): DEX’s use AMM’s to manage liquidity pools. An AMM is a smart contract that automatically adjusts the prices based on the amount of each asset in the liquidity pool. It ensures that trades can be executed continuously without needing a traditional order book.
Risks Of Providing Liquidity
Providing liquidity doesn’t come without risk. While the process is entirely managed with a smart contract, there is still risk involved. As always, you must consider smart contract security, market stability, and the fee structure. However, the primary risk of providing liquidity is called ‘Impermanent Loss’ (IL).
Impermanent loss occurs when the value of the assets in your liquidity pool changes compared to holding them in your wallet. This happens because the prices of the assets in the pool fluctuate, affecting the balance of assets and their relative values. If you provide liquidity to a pool and the price of one asset rises significantly compared to the other, you might end up with less of the appreciating asset when you withdraw your funds. This could result in a lower value of your total assets compared to if you had simply held them outside the pool.
Consider the following scenario using an ETH/USDC pool to better understand impermanent loss:
Initial Deposit: You deposit 1 ETH (worth $1000) and $1000 USDC. The total value is $2000.
Price Change: ETH’s price rises to $1200
Withdrawn Value: After the price change, you withdraw and get .85 ETH and $1020 USDC. Value of .85 ETH at $1200 = $1020. Added with the $1020 USDC, you have $2040.
Value if Held: If you had just held the 1 ETH and $1000 USDC, it would be worth $1200 (ETH) + $1000 (USDC) = $2,200.
Impermanent Loss: Value in the pool: $2040. Value if held: $2200. Impermanent Loss is $2200 - $2040 = $160.
In the above example, impermanent loss is $160 or 7.27%, meaning you would have been better off holding the assets rather than providing liquidity. However, you have to consider any incentives or fees earned before calculating overall profitability.
How To Provide Liquidity On A DEX
Now that you understand the basics, I will walk you through the steps for providing liquidity. In the example below, I will be providing liquidity for TN100x & ETH on Aerodrome. This pool is currently incentivized with AERO emissions, making the APR very lucrative. Please note that the process for adding liquidity may be slightly different depending on which DEX you are working with.
Step 1: Go to https://aerodrome.finance/ and click the 'Connect' button in the top right hand corner. This will connect your wallet to Aerodrome.
Step 2: Navigate to the ‘Liquidity’ tab at the top of the page. This will take you to a page with all active liquidity pools on Aerodrome. From here, you can either search for the pool you would like to deposit funds into. Search for TN100x and click the ‘Deposit’ button.
Step 3: On this page, you deposit an equal amount of both assets into the liquidity pool. In our case, we will be depositing TN100x and ETH. Input the amounts you would like to deposit and then click the ‘Allow’ buttons to the right for both WETH & TN100x. After you allow both TN100x & ETH, click Deposit and confirm the transaction in your wallet.
Congratulations! You are now providing liquidity on Aerodrome. But, we’re not quite done. Now we need to stake your deposit to earn incentivized AERO emissions.
Step 4: Navigate to the ‘Dashboard’ tab again. From there, you will see the liquidity that you just provided, along with options to ‘deposit’ ‘withdraw’ and ‘stake’. Choose ‘Stake’.
Step 5: On this page, you will see a sliding bar which allows you to determine how much of your deposit you want to stake. Choose the amount you want to stake and then click ‘Allow vAMM-WETH/TN100x’. After the contract is allowed, click the ‘Stake’ button to finish the process.
That’s it! You are now providing liquidity for TN100x & ETH on Aerodrome and earning 250% APR in AERO emissions. Please note that the APR will fluctuate depending on a number of factors including volume.
This was an introductory lesson on providing liquidity. There is a lot more to it than this, but it should be a good place for you to start. In our next lesson, we will cover providing concentrated liquidity on a DEX like Uniswap. Concentrated liquidity allows you to be more capital efficient and earn more in fees but it also increases the risk of impermanent loss.
Now, get out there and give it a try! It’s honestly the best way to learn about providing liquidity. Start small and take your time until you get the hang of it!
really helpful and informative. thanks fam🫶
Thank you so much,this is very educative.thanks also for the enlightenment.
Thank you! As a beginner the explanations and steps were clear and concise.
Moxie emissions on Aerodrome have been over 350% all week. If you have unused moxie and you DON’T have it in LP, you’re really missing out on some juicy rewards.
Drop the tutorial pls
This is with tn100x but you can swap out moxie and all the steps are the same. https://paragraph.xyz/@maretus.eth/lesson-on-liquidity
I agree, this is great! And then the aero token can be taken to rebase
Is this also similar to earning rewards through staking?
Kind of, yes
Oh, I need to try that right away!
APR 364...% awesome
Best way!! I think this is more beneficial than buying fan tokens.
Thanks for good information bro
yup im already follow u n have it in LP
Can i unstake all the moxie any time or there are some specific time conditions in this?
You can unstake at anytime.
Moxie LP rewards on Aerodrome have been holding steady at 350%+ APR for the last 3 days. Over 60 AERO per day from this size deposit currently. 🤯
Damn that is what you call yield.
Yeah for real. Aerodrome is awesome. I actually love simplified LPs rather than V3 Uniswap which always ends up out of range unless you set it to full and that’s hard for a gambler like me lol.
I’ve never used it, but all for simplicity!
i've been meaning to do this.. can i withdraw anytime though?
Yep, it’s not locked :)
whew okay that's all i needed to know haha thank you!
I've only got a $50 total deposit in there, but it's earning FAR better than any savings account ever, so I'll be adding more as I go. Build from scratch and see how far it can grow. Perks of being chronically online is I can monitor and move it if it starts to drop too much.
Might need to get in on this...
Now those are some juicy rewards 🙉 Seriously need to stop sleeping on LPs
This is something like stake? I can withdraw anytime?
Yea, it’s kind of like staking. You provide eth and moxie to aerodrome in a smart contract and receive aero rewards as emissions. Here’s a blog post explaining it: https://paragraph.xyz/@maretus.eth/lesson-on-liquidity
https://media0.giphy.com/media/nuRXXyy020kta/giphy.gif?cid=6c09b9529w1jpdmeshuncrxthcqms16vygxze8znqa9oyifx&ep=v1_internal_gif_by_id&rid=giphy.gif
bravo man, thank you for all that you do. 400 $degen
Thanks dude! Much appreciated!
How i wish have funds like that 😅
Debank?
One thing Warpcast might benefit from is the ability to write threads in the style of Twitter/X. They are useful for stringing together complex arguments or unpacking information in a sequential way. In my experience they also drive engagement because it can be exciting for other users to see what comes next in a particularly captivating thread and incentivize them to wait around until it finishes playing out. Some particularly erudite or evocative threads live on as reference points that people can return to in order to cite certain information and arguments. Personally, I really enjoy sharing important passages from books in threads that others can follow along with and that I can also return to for citations. It lets others get the key arguments of the book and also serves as a reference point for myself for future.
Maybe try SuperCast when you want to write long threads. Last time I checked you can add more comments as you compose.
on roadmap
Nice
I was asking last year but dwr said it wasn't an important feature 🤷🏽
Any way to make it so that when we clock "show more" it expands right there on the current screen instead of entering the cast view?
yo, would love to have you check out supercast! we have threads, although the mobile experience is slightly limited compared to warpcast
I’m definitely more likely to read a 1000-word thread than a single 1000-word tweet.
Yeah u can already but the wc algo is weird and doesn't display thread properly. Also replies tend to be more muted in selection on the feed, so quote casts tend to fare better
I kinda think blog posts from paragraph serve the purpose even better here. Have you seen those? It condenses a blog post into a single frame that you can click arrows thru to read paragraph by paragraph. Here is an example: https://paragraph.xyz/@maretus.eth/lesson-on-liquidity
I have, honestly its good but I'm just so used to threading
great suggestion here, murtaza! i think supercast does this already but it’ll be a super helpful warpcast adds it to their roadmap!
I think this could easily be a standalone app too. 🤔
this and lists, really miss them 🍖 x10 $DEGEN 99 $WILD
This is a great explanation on liquidity pools, how they work, and how to earn. /masks is another token that's super easy to provide liquidity for 🎭 cc: @maretus https://paragraph.xyz/@maretus.eth/lesson-on-liquidity?referrer=0x495E4f8C59f9b2df760F77C42f27ea514697bf73
Are you still sleeping on Aerodrome LP rewards for TN100x? You really shouldn’t be. What’s that? You don’t know how to add LP? It’s your lucky day - I wrote a blog post about it, complete with example screenshots! https://paragraph.xyz/@maretus.eth/lesson-on-liquidity
🍖x5000
👀 👀
Thank you! I have no idea what you are talking about
You add LP to aerodrome and get 250% APR.
well.... that sounds good.... I will have to actually read your article tomorrow when my brain can process new information
I'll be honest thought, I subbed and didn't read, my brain is too tired to make sense.
Go to bed already! 😉 100 $degen
It's only 8:45 PM! I am resting my soul with Warpcast 😂 🎭
I'm not! I am earning too hehe!
great advice here.... love my @aerodrome rewards....
Thanks! 🍖x 300
Deployed just keeps deploying
🍖x500
🍖x690
I am indeed sleeping and need to wake tf up 🙉🍖x69
Another Wednesday, another Weekly Digest, where we spotlight a few great pieces of writing over the past month or so. First up is @stc and his fascinating explorations into the concepts and methods behind his algorithmic plotter graphics series “Procedural Drawings”. https://paragraph.xyz/@stc/time-shifting
Next, @rtfkt dives into the lifecycle of online communities — Inception, Establishment, Maturity, and Mitosis or Revival — and highlights the importance of communication and value to prevent community stagnation and fragmentation. https://paragraph.xyz/@kalen/the-pulse-of-online-communities-navigating-the-lifecycle
@zoz.eth writes about how decentralized social graphs are evolving into dynamic ecosystems, but the primary challenge is achieving a self-sustaining growth cycle. Success in this domain will come from focusing on high-quality, engaging content rather than superficial feature tweaks, ensuring the amplification of ideas that attract and retain thoughtful users. https://paragraph.xyz/@0xzoz/the-infinite-client-1
@ispeaknerd.eth discusses strategies for securing onchain and social identities in the web3 landscape using Ethereum Name Service (ENS) and Farcaster, emphasizing the importance of managing multiple wallets for different activities to safeguard one’s reputation and digital assets. https://paragraph.xyz/@ispeaknerd.eth/passport-control-for-onchain-and-social-identities
Over the last few weeks, I have had a number of people ask me how to provide liquidity for things like /lp or /farther. As someone who prefers to learn from experience, I wasted a lot of time and even more money learning how liquidity pools worked. So, I'm sharing this knowledge in a blog post! https://paragraph.xyz/@maretus.eth/lesson-on-liquidity
Bookmarked this to check out when I have a little more time, always wanted to learn/know more about LP's. Thanks for taking the time to share this!
Hell yea dude! I hope it’s helpful for you. I tried to make it super easy and simple to follow :)
🍖x5000
Thank you for sharing king🫶🏾💜
great content. 💜👊
Thanks mate. @jpfraneto.eth encouraged me to spend more time producing content like this for the community and I think he’s right, so I’m going to keep it up. Try to give people a more normie understanding of stuff. 🤷♂️
this is the kind of stuff FC needs 💯
🍖x10
Thanks :)
These have ALWAYS been something I didn't venture into... Maybe I should start? Thanks for this @maretus! 🍖 x 69 $degen
Well, if you’re already holding tn100x and eth, you might want to consider it. Aero emissions are really good rn. My 2k in LP is making almost $20/day in emissions. 🤷♂️
Gonna dive into this later tonight. Ty bro!!!
Sure thing! I hope it helps :)
This is a really detailed description. Not long ago, I looked for a liquidity for the Imagine token, but it was difficult because there was not much data. It's a very helpful material for me because tokens are different and the way they do it is the same. Thank you so much, boss.
Heck yea, I’m glad it could be helpful for you! I’ll do another one about more complicated liquidity pools next! :)
Thank you so much, you're the best. 🧡
omg..i just saw this tysm!!!!! 50 $hunt
I've tried it several times before, but I never really understood it. Finally, a great explanation. Thank you for that. 🍖x300
Hell yea! I’m glad you liked it. Aerodrome makes it rather easy with incentivized pools. Next blog post will be about concentrated liquidity at places like Uniswap.
🍖 x20