Thread by @cryptobafemi

Let's Read about Liquidity Pools.

They are a VERY IMPORTANT component in Web3 / DeFi.

𝗪𝗵𝗮𝘁 𝗮𝗿𝗲 𝗟𝗶𝗾𝘂𝗶𝗱𝗶𝘁𝘆 𝗣𝗼𝗼𝗹𝘀?

How do they function?

What is their utility?

A Thread 🧵

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A Liquidity pool is a pair of tokens pulled together proportionally in a smart contract.

They are used to provide liquidity for Decentralised Exchanges (DEXes).
1/n

𝗢𝗕𝗠

When we look at Stock Exchange or Centralised crypto exchanges like Robinhood and FTX; they operate on the order book model (ODM).

An order is placed to buy a stock or crypto at certain price and the transaction is successful if someone is willing to sell at that price.

1. The buyers trybto buy as low as possible.

2. The sellers try to sell as high as possible.

But in a situation where the buyers and sellers do not agree on a price, what happens? This is where the Market Makers come in.

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Market Makers (MM)

The Market Makers are the middle ground for buyers and sellers. They are always ready to buy and sell. They provide liquidity for the Market.

In DeFi; OBM and Market Makers can't operate effectively.

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𝗪𝗵𝘆 𝗢𝗕𝗠 𝗮𝗻𝗱 𝗠𝗮𝗿𝗸𝗲𝘁 𝗠𝗮𝗸𝗲𝗿𝘀 𝗰𝗮𝗻'𝘁 𝘄𝗼𝗿𝗸 𝗶𝗻 𝗗𝗲𝗙𝗶

- It's slow and expensive.
- Each interaction has a gas fee.
- Market Makers would lose money.

A Liquidity Pools is used with an Automated Market Maker being it's important component.

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How Liquidity Pools Work

- Equal proportions of the tokens are locked in.

E.g. $50 worth of DAI and $50 worth of #ETH

- The Automated Market Maker (AMM) allows the tokens to be traded in and out of the liquidity pool whilst still keeping it equal in proportion.

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For example: Buying ETH with DAI increases the supply of DAI whilst making it cheaper and ETH becomes more expensive, Vice versa..

-#Liquidity pools can hold assets as much as $2 million dollars so a trade of $2000 for example won't affect the prices very much.

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- DEXs also help in trading assets between different Liquidity Pools. For example ETH can be trade with SDL by connecting ETH/DAI pool to SDL/DAI pool. This process is called ROUTING

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𝗔𝗱𝘃𝗮𝗻𝘁𝗮𝗴𝗲𝘀 𝗼𝗳 𝗟𝗶𝗾𝘂𝗶𝗱𝗶𝘁𝘆 𝗣𝗼𝗼𝗹𝘀

-Simplifies DEX trading by performing transactions at real-time market prices.

-Allows people to provide liquidity and receive rewards (Liquidity Mining).

-Uses publicly viewable smart contracts making it secure.

9/n

𝗣𝗼𝗽𝘂𝗹𝗮𝗿 𝗹𝗶𝗾𝘂𝗶𝗱𝗶𝘁𝘆 𝗽𝗼𝗼𝗹 𝗽𝗿𝗼𝘃𝗶𝗱𝗲𝗿𝘀

Uniswap

Curve

Balancer

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Recap ⤵️
0: Let's read about Liquidity Pools
1: Liquidity Pools (Definition)
2: Order Book Model (OBM)
3: OBM cont'd
4: Market Makers (MM)
5: Why OBM and Market Makers can't work in DeFi
6-8: How Liquidity Pools Work
9: Advantages of Liquidity Pools.
10:Liquidity Pools ProvidersI

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Check out last weeks thread on Stable coins👇👇👇