What is Liquidity Provisioning?
In order to understand liquidity providing or liquidity mining, one must first understand the basic concept behind liquidity pools.
In brief, a liquidity pool (LP) is a collection of funds locked in a smart contract for the purpose of facilitating trades on decentralized exchanges. Most LP’s consist of two or more tokens, however some consist of three or more tokens. In its most basic form, a single liquidity pool will hold a pair of tokens in a 50:50 ratio, but there are LP’s with different ratios or multiple tokens. Liquidity providers are rewarded for providing this service by receiving a portion of the trading fees transaction in that pool. LPs are one of the fundamental building blocks of DeFi since they provide access to currency exchanges across almost all tokens in DeFi.
The mechanics of providing liquidity start when a token holder makes a deposit of one or more tokens into a liquidity pool (assuming the token is acceptable). A new token is automatically generated, which represents the share the depositor owns of the pool - called a liquidity provider (LP) token. These LP tokens represent the current value of the token pair locked into the pool and the trading fees generated from that pool. These LP tokens can be kept in your wallet or used with other services to generate additional yield. There are often many potential use cases for these LP tokens, both within the native platform as well as other decentralized finance apps.
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An LP provider MUST be aware of ”impermanent loss” (IL) which occurs when there’s a divergence between the price of an asset within a liquidity pool and the price of that asset outside of the liquidity pool. In some cases, the pool could end up “unbalanced” with an LP that consists almost entirely of a single token. It is generally advised that you should only provide liquidity for tokens that you would like to own.
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As the ecosystem matures and yield farming opportunities continue to blossom across numerous competent projects, there is an imminent problem that might hinder the success of many interested market participants. The sheer number of existing projects and the introduction of new ones (both legitimate and scams, unfortunately) can rightly create a degree of caution. ”Rug pulls” are a legitimate concern for any yield farmer. A one-stop shop for all things DeFi is what the liquidity provider needs today, and urgently.
Limited true decentralization, lack of farming options, and provider bias are some of the many factors that need to be addressed. In order for a DeFi project to blossom, it needs access to potential liquidity providers to achieve optimal liquidity and make prospects rewarding for its community. There is a real need in this space for a remedy that enables a seamless flow of yields for the user and liquidity for the market as a whole. And the answer presents itself in the form of – Yield Enhancement Labs!