Understanding liquidity pools

Introduction

In traditional finance, an order book is used to match buyers and sellers at a specific price. In contrast, A liquidity pool is a pool of assets that are made available for trading on a decentralized exchange (DEX). The assets in the pool are typically locked up by individuals or organizations called liquidity providers, who earn a percentage of trading fees in return for providing liquidity to the pool (the mechanism with USDFI is slightly different, here the veSTABLE holders can earn the fees).

The primary function of a liquidity pool is to ensure that there is always a buyer and seller available for a given asset pair on the DEX. By depositing assets into the pool, liquidity providers are effectively making a market for that asset, allowing traders to buy and sell it without having to wait for a counterparty.

The price at which an asset can be traded in a liquidity pool is determined by the relative value of the assets in the pool. The price is set by a mathematical formula, called an Automated Market Maker (AMM) algorithm, which takes into account the total value of the assets in the pool, as well as the relative amounts of each asset.

When a trader wants to buy or sell an asset, they interact with the liquidity pool smart contract, which executes the trade and updates the pool's balances. The AMM algorithm ensures that the price of the assets remains stable and that liquidity providers earn a fair return on their investment.

Overall, liquidity pools play a crucial role in making DEXs functional, by providing a mechanism for ensuring that assets can be bought and sold without the need for a centralized intermediary.

Liquidity Pools on USDFI

Providing liquidity carries certain risks. In this section, the different pools within the USDFI ecosystem will be reviewed, in order to assist users in finding a pool that aligns with their risk tolerance. The risks associated with being a liquidity provider on USDFI will also be explained.

At present, there are several USDFI pools available, with new pools being added on a regular basis subject to whitelisting. It is important to note that when providing liquidity to a pool, one is exposed to both tokens within the pool regardless of the tokens deposited, therefore it is crucial to choose a pool with coins that a user is comfortable holding.

All USDFI liquidity gauges receive STABLE based on how much the DAO allocates to it.

All USDFI liquidity gauges receive STABLE based on how much the DAO allocates to it.

The AMM concept

Liquidity pools are pools of tokens that exist within smart contracts. They can be a complex concept to understand, particularly for those new to Ethereum or DeFi. As an example, if one were to create a pool consisting of both USDT and USDC, where 1 USDT is equal to 1 USDC, and the pool contains 1,000 tokens of each (1,000 USDT and 1,000 USDC), If a trader exchanges 100 USDT for 100 USDC, the pool would then contain 1,100 USDT and 900 USDC, causing the price of USDC to slightly decrease in order to encourage another trader to exchange USDC for USDT, thus balancing the pool again.

APY

It is important to understand the role of the different pools in USDFI and how liquidity providers earn money. USDFI earns revenue from trading fees. When a user exchanges tokens through the USDFI website, 1inch, Paraswap, or another decentralized exchange aggregator, a small fee is earned and distributed as a bribe to veSTABLE holders, split evenly among all holders. APY may be higher on days with high volume and volatility; and may be low on some days.

Fees

Swap fees on USDFI for sAMM are generally 0.04% and for vAMM 0.30%, which is considered to be one of the most efficient ways to exchange stablecoins and other tokens on the any EVM blockchain. Deposit and withdrawal fees are 0% in the protocol. There may be network fees.