Liquidity pools
Liquidity pools are crucial for peer-to-peer trading in decentralized finance (DeFi). Here’s everything you need to know about how they work.
A liquidity pool is a group of tokens that are locked in a smart contract and used for trading between assets on a decentralized exchange (DEX) like Uniswap. Each liquidity pool is a trading venue for a pair of ERC20 tokens.
In traditional finance, liquidity is organized using a central limit order book where buyers and sellers create orders (trade) organized by price and demand. The Uniswap Protocol takes a different approach, using an Automatic Market Maker (AMM) to replace the traditional order book method with a liquidity pool of two assets, where an AMM determines the price.
Automated market maker (AMM) algorithms in the contract determine the price of each token and adjust prices in real time depending on supply and demand. This ensures that the supply of each token in a pool is always in proportion to the other tokens in the pool.
Initial liquidity
When a pool contract is created, the balances of each token are 0. In order for the pool to begin facilitating trades, someone must seed it with an initial deposit of each token. This first liquidity provider is the one who sets the initial price of the pool.
They are incentivized to deposit an equal value of both tokens into the pool. If the first liquidity provider deposits tokens at a ratio different from the current market rate, this immediately creates a profitable arbitrage opportunity, which is likely to be taken by an external party.
LP tokens (Liquidity pool tokens)
When a user deposits tokens into a pool, they receive an ERC20 token representing their share of the pool, called a liquidity token. This token is minted when the user deposits and burned when the user withdraws. The balance of the liquidity token represents the user’s share of the pool.
As liquidity tokens are themselves tradable assets, liquidity providers may sell, transfer, or otherwise use their liquidity tokens in any way they see fit.
Important for traders
It is important to evaluate the liquidity available in a pool before swapping. A pool with low liquidity will not give you an optimal price and could potentially result in a loss.
Some advice for traders:
Seek out pools that have a high trading volume and a significant amount of liquidity;
Checking to see whether the liquid asset pool is supported by a strong developer community and has an active user base;
Once assets have been added to a liquidity pool, they are controlled by a smart contract. If a malicious actor gains access to a smart contract that controls a liquidity pool, they may be able to steal all the funds in the pool.
Blokiments metrics and filters
Blokiments app can help you to find the best liquidity pools for your trading strategy. You can use filters to find the best pools and metrics to evaluate them.
Filters
Liquidity in USDfilter - you can filter pools by the amount of liquidity in USD. This filter is good to be more than $80,000.Liquidity Change in USDfilter - the change of the liquidity in the pool in the last 1, 7, 30 days. Try to find pools with a positive change in liquidity (1d interval works well for new tokens). This means that the pool is growing, and more people are using it.
Pro tip: Sort the results by Blokiments Score to find the best pairs.
Metrics
Initial Liquiditymetric - In the detail view for the pair, under the liquidity section, you can find the amount of liquidity added by the creators of the analyzed pairs.
Sources
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