Note: This is a lesson from my Free DEX Course (here).
Liquidity pools are groups or pairings of assets on a blockchain that we trade against. A user interface (site or app) allows traders to swap between their personal crypto wallet and the liquidity pool directly. This is the basis of decentralized exchanges (DEXs). Watch the vid!
What’s So New about Liquidity Pools?
Pools are controlled by smart contracts (blockchain code) that lock up assets. To compare with the old ways of trading, we no longer need a buyer to buy exactly what we are selling.
In the new ways of decentralized finance (DeFi) and decentralized exchanges (DEXs), crypto coins, tokenized assets, and stablecoins get locked up in smart contracts for trade. These contracts are programs that live on a blockchain and cannot be changed. They are programmed to execute automatically, sitting and waiting for a trade.
How are Liquidity Pools Funded?
Exchanges provide incentives for users to “crowd fund” a liquidity trading pool. Liquidity providers can be awarded parts of the trading fees or gain crypto in other ways. This could be considered a new way of earning interest with crypto.
Liquidity pools work alongside automated market makers (AMMs). AMMs are other chunks of code that determine the price of assets compared to the amount that are available in the pool. They are run by a simple formula to keep supply and price constant.
Wild Speculations about Future Liquidity Pools
The big trends in DeFi and DEXs are cross-chain swaps and tokenizing of traditional assets such as stocks, funds, etc. There are early efforts at bridging different blockchains, though they have been plagued by hacks.
Fiat money continues to be locked up and go on various blockchains in the form of stablecoins. “Wrapped” crypto allows coins to be traded on DEXs that are not their home blockchain too.
All of these efforts are combining in different projects and frameworks. Blockchain ecosystems are beginning to “link up” in other words. In my view, liquidity pools connecting together is the next natural trend.
The near future of decentralized trade will be run on massive pools. We will be trading nearly any crypto for nearly every type of traditional asset that has been tokenized on-chain. The plumbing is starting to come together in DeFi.
It will be 24/7 trading of every kind of asset that can be also be frationalized too. Of course, point of sale will also plug in to all this. That’s all pure speculation, of course!