Liquidity pools or pools of tokens or pools of assets are nothing but a decentralized smart contract that locks up the crypto tokens or crypto assets. This lock-up of assets is done to facilitate the crypto trading by providing greater liquidity.
This concept of Liquidity pools became popular in DeFi, after the launch of the famous DeFi liquidity pool Uniswap.
The crypto users who stake or store their assets in these liquidity pools to
yield more assets or income through the concept of DeFi Yield Farming are known as liquidity providers.
Why do we need Liquidity Pools in DeFi?
Most of the familiar crypto exchanges work on the basis of the Order Book Model, where buyers and sellers come together and place an order. And there come market makers who facilitate the trading by always willing to buy/sell assets. This makes the users trade anytime without waiting for any counterparties by providing high liquidity.
This same concept of market makers or liquidity pools can also be implemented in Decentralized Finance to reduce the issues of liquidity in DeFi.Without market makers, any platform would become illiquid and unusable for users of the platform. Since, most of the DeFi platforms are on Ethereum, which collects Gas fees for each and every transaction on smart contracts, which can make transactions cost-effective and may face many liquidity issues.
Thus, the involvement of DeFi liquidity pools can play a vital role in maintaining liquidity in decentralized finance.
Key Advantages of Liquidity Pools in DeFi
Provides and bootstrap liquidity Providing Network
Offers added assurance for large investors
Acts as Insurance for Token holders
Helps for fast cross border transactions with automated smart contracts
Reduces Liquidity Risks in decentralized finance.
Lower Gas Fees
Liquidity Providers earn passive income
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