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Liquidity Pools, Trading Pairs, and User APIs

Wisebitcoin 2021-05-13

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Liquidity pools are quite popular among the crypto crowd in favor of decentralized exchanges. In the DeFi (Decentralized Finance) space, smart contracts are used to manage the exchange of liquidity tokens for a share of the commission earned by a pool.

Unlike the use of order books on traditional exchanges, an algorithm (the Automated Market Maker) executes trades between sell and buy prices that are listed and takes care of the demands of its users by keeping the price fair on par with the market value.

 

How Liquidity Pools Work on Wisebitcoin

Liquidity partners are rewarded in proportion to their contributions to the pool. When they make a deposit, they receive a pool token with their stake. Investors can return the token and withdraw a proportional share of their pooled assets and trading fees to liquidate.

The first liquidity provider of the pool sets its initial price. This is to ensure that no one puts the pool at risk by arbitraging the difference from the market price. All the other pool investors are encouraged to deposit an equal value of both tokens into the pool.

In this scenario, there is no need for any other bookkeeper. One requires sufficient liquidity in the pool.

The user API (Application Programming Interface) for crypto trading at Wisebitcoin enables you to interact with the exchange through an algorithm. The API functions extend to aspects such as:

  • Downloading market data and streaming it in real-time
  • Placing or canceling trading orders
  • Viewing account balances and checking the status of transactions

The API makes it easy to place orders, track price movements, and make data-driven investment decisions. With access to better data - and with tools that make investment easier -  investors will be better prepared to invest their funds in the pools, tokens, or assets that make the most financial sense and they will be able to seamlessly deposit funds into different pools and make other transactions with their assets. The more easily that investors can perform such actions, the better it is for the overall liquidity of the network.

When an investor creates a trading pair between, say, DAI to Ethereum on Wisebitcoin, their liquidity is tapped into. If an investor invests $100 of DAI and Ethereum each, that means they have $200 in total in the pool. The investor will receive tokens proportional to their investment.

If another investor wants to trade DAI for Ethereum or vice versa, the value of the pool will shift accordingly. The Ethereum liquidity might shrink, or it could happen to DAI, but overall, the value of your token remains the same. The smart contract manages this.

Finally, when you withdraw, you get a percentage proportional to the amount you invested and the fees you have earned since then. 

 

Returns in Liquidity Pools and Trading Pairs

The returns in liquidity pools depend on three factors

  • Asset prices while contributing or withdrawing
  • Liquidity pool size
  • Trading volumes

 

The smallest unit of a liquidity pool can have two tokens bonded in a smart contract to form a trading pair.

 

To retrieve the investment through liquidity, the investor must burn their pool tokens and exchange them for their portion of the liquidity pool, including the fee allocation. Since the management of the differences in the ETH and the token will depend on the investors in the pool, you would have a looser grip on the ratio of the investment. Still, liquidity pools have many important uses.

 

Benefits of Liquidity Pools

Guaranteed liquidity

Wisebitcoin encourages its investors to choose liquidity pools for many reasons. One of the foremost reasons is their potential for an unlimited supply of liquidity by removing the dependence of tokens on trade volume. This means that traders don't have to match up with other traders while all they need is enough assets in the pool.

Automated pricing

At order book exchanges that practically run on the same principle as traditional markets but for centralized cryptocurrencies, bids need to be manually adjusted to match market prices. At liquidity exchanges, however, smart contracts take care of pricing. Order books were made when fewer assets were being traded but weren't made for users to generate tokens under minimum liquidity.

Fewer restrictions on investors

There is no need to show any KYC or other identification to join a liquidity pool. Anyone can join and create a new exchange pair for any token at any time. A percentage of the trading fee of the pool is added to your rate of investment. For example, if your share is 0.009% of the total pool and the trading fee is 0.3%, you will get 0.009% of that 0.3% trading fee.

Lower transaction fees

Traditional cryptocurrency exchanges typically charge between 0.10% and 0.30% maker and taker fees. Wisebitcoin charges 0.07% for maker fees and 0.07% for taker fees. Lower commissions work toward improving trader earnings, incentivizing investors to bring their funds onto the Wisebitcoin platform.

 

Risks in Liquidity Pools

Depositing funds into a liquidity pool is similar to staking or locking your tokens in a fund. Since investors receive liquidity pool tokens commensurate with the value of the assets they contribute to the pool if the price of an asset rises after the investor deposits that asset to a pool, this represents a lost opportunity. The larger the change, the more significant the fall in dollar value at the time of withdrawal.

However, it should be kept in mind that price fluctuations and the opportunity costs of holding or investing in tokens is a constant for the crypto space irrespective of where funds are invested, but since liquidity pools provide investors with a share of mining fees, these earnings can offset any income losses suffered from price changes that occur while an asset is deployed in a pool.

 

Conclusion

Liquidity pools are fundamental to DeFi crypto exchanges. Wisebitcoin welcomes new and veteran crypto enthusiasts to participate in decentralized trading and utilize the power of smart contracts to their full extent. Visit Wisebitcoin to learn more.