One of the main “superpowers” of having your own blockchain is the power of having a Liquidity Pool (LP).
However, for many, the idea of creating a Liquidity Pool strikes as something awesome, but deep down, they are asking themselves “what on earth do pools have to do with anything crypto?”.
Once again, never fear: this article was made to explain, briefly and in the most accessible way, some important topics regarding this subject, such as:
1. What is a Liquidity Pool?
2. Why would an exchange need a Liquidity Pool?
3. How does it work?
4. How will Klever implement Liquidity Pools and how to participate in them?
What is a Liquidity Pool?
By that name, I wouldn’t judge you if you thought this was just a rectangle full of water.
But actually, Liquidity Pools are somewhat “pools full of money” invested by users – in our case, full of cryptocurrency.
Those funds are given by investors who wish to collaborate with a crypto pair’s liquidity in exchange for rewards.
So yes, it is correct to say that this is another form of having passive income.
By putting your crypto inside the “pool”, you are providing liquidity to the exchange and, in return, you’ll have your share in the liquidity pool rewards.
Why would an exchange need a Liquidity Pool?
I truly believe that the best way to understand this concept is also by understanding why it is needed.
Once you see the problem, you’ll be able to comprehend why people came up with this idea to try to fix an issue.
So, let’s begin with the concept of Liquidity:
Liquidity is the availability of tokens in a market. In other words, if you have a great deal of money to purchase an asset but none of it can be traded because there is no one to trade it with or to provide the asset, you have no liquidity.
In a crypto exchange having no liquidity means the lack of tokens to trade.
If you go into an exchange and there’s not enough crypto to be traded there, you’ll feel the lack of ‘depth’ to provide the perfect match between the orders.
In a clearer example let’s say you wish to buy 2 KLV for 0.50. But on the opposite side, there’s only one person selling 1 KLV and for 1.0500 (imaginary numbers, ok?).
You won’t have that variety of orders to fulfill yours, because there is no liquidity there.
Liquidity pools come to fix this issue as it injects more liquidity – or more crypto orders – inside the pair’s order book. So you’ll have more options to trade with and, consequently, more offers of crypto at various prices aiming to fulfill more orders.
But, you can ask now: “how come this situation happens?”
Well, in most cases, this is the situation faced by new exchanges that still don’t have that significant amount of traders inside the exchange to provide that liquidity.
So, we want the global crypto community to enjoy the best, safest and fastest exchange there is – like the Klever Exchange – but, in the beginning, it is normal to work with liquidity pools once the number of traders is still growing.
How does a Liquidity Pool work?
As previously mentioned, Liquidity Pools are funds given by investors who wish to help with the exchange’s liquidity in return for rewards.
However, how would it work in a practical way?
Liquidity Pools are created to work with crypto exchange pairs such as KLV/BTC, KLV/USDT, and so on. So, first, investors choose the crypto pair available for pools in the exchange.
Each pool will have a type of reward to be handed once the established deadline arrives. It also has a minimum amount to be invested in it.
Some exchanges offer fixed amounts as rewards and others a variable amount that changes the more funds are invested inside it.
After choosing the pair and putting the amount you wish to invest, you’ll be participating in the Liquidity Pool and those funds will start to work inside the crypto pair’s order book.
And now comes the magic!
Through automated market makers that will trade with the funds provided by investors, Klever is able to provide liquidity to the pairs of each created Liquidity Pool.
This improves the experience of using our product and in exchange for the support of our community, Klever pays a reward to users who collaborate to form the Liquidity Pool.
Wait, I won’t go any further without explaining this new one.
Automated Market Makers (AMM)
Automated market makers are computer programs that will do the math of how much the prices of the coins are per amount, make an order, and put it in the order book.
This way, the order book will have more “depth”, meaning that it’ll have more variety of orders at different prices and amounts – or, as we learned, provide liquidity.
In other words, AMMs are bots that work through smart contracts and operate with the investors’ money that they provided through the liquidity pool.
It is also good to point out that Liquidity Pools usually work with a 50:50 rate of distribution of investors’ funds between the tokens. It means that the money you send to the liquidity pool will be calculated in a way that it is proportional to both tokens in the pair.
For example: if you invest in an LP of KLV/BTC, the funds will be split to provide liquidity equally between those two tokens first. But then, depending on the demands, an imbalance can occur over time, and that’s part of the market’s natural behavior.
Let’s say we start with the same amount of KLV and BTC inside the exchange pair.
However, with time, people purchased more KLV than BTC. This will lead to the common law of demand and KLV will have higher prices.
This balance is calculated through the system so the proportions will always be correct between those cryptos.
How will Liquidity Pools work in Klever?
So, now that you understand a little bit more about LPs, let’s see how they will work in Klever.
This graphic right below shows an idea of how the options of LPs will be displayed on our website.
You can see that in the LP box there is some important information for the investor to know before he/she “dives into the pool”. Amongst them, those are fundamental:
- Total Yield
- Date of beginning and end of the pool
And, the finished version will also add:
- Initial reward
- Bonus reward
Here’s a short description of each of these figures:
1. Total Yield
The total yield represents the estimated percentage of profit that investors will have on that pair in a period of one year.
This means that it calculates the possible profit of those cryptos in a year – it works similarly to the APR in staking.
2. Date of beginning and end of the pool
Every LP has an hour and date to start and finish. The investors can “jump in” the pool in this period. Once it’s done, the pool closes and the final rewards are distributed.
3. Initial Reward
It’s the reward that will be distributed proportionally throughout the period of the LP to all the investors.
However, Klever added a limit of investment in each pool in order to prevent the case of having a huge whale investing in it and getting the majority of the reward distribution, since this distribution is proportional.
The initial reward can be claimed every hour if the investor wishes to claim it before the end of the pool. The user just needs to click on the ‘Claim’ button and withdraw their prize.
This reward will be paid in KLV.
4. Bonus Reward
In addition, Klever will also pay investors a Bonus Reward, fixed before the LP starts.
This will be paid in KFI, the governance token of Klever, and it’s also proportional to the user’s investment.
This one will only be available for claiming by the end date of the pool.
If the user withdraws the funds before the end date of the Liquidity Pool, he/she will not be eligible to receive the bonus reward.
To add funds to the LP is pretty simple, especially when you already understand what it is and how it works.
The image above shows an example of when you click on ‘Add Liquidity’.
Once you’ve chosen the pair you wish to collaborate with, you can insert the amount you want to give and the token you will pay it with and then the system will automatically calculate the proportion of the other token.
On the other box located on the right side, you’ll be able to see all the info about the LP in more detail, like the exact proportion of coins, the rate share of the pool, the total yield, and the percentage of rewards based on your contribution.
After making your participation in the pool, your Holdings Overview will be displayed like this:
In addition, I can’t finish this article without answering a very common question:
The difference between LPs and Staking
You can now ask ‘but why would I participate in an LP instead of just Staking? Which one is more profitable?’.
Well, first, let’s remember that both of them have completely different purposes.
While LPs are to provide liquidity in the exchange, staking is a way of investing in a company’s token to help improve that project and participate in the consensus mechanism.
Both offer rewards, but while staking has a fixed APR, the total pool yield can become very attractive as it pays higher rewards and permanence bonuses.
When you stake your coins, you know your APR. But when you use LPs, you operate with Total Yields that can vary for better, and by not participating in it, you can lose a good opportunity.
Another Klever feature
At the end of the day, Liquidity Pools are one more feature to be offered to the Klever community in a fast, secure, and accessible way that only Klever knows how to do.
Throughout the next few weeks, we’ll be publishing more content about Liquidity Pools in order for you to understand even better how that engine works and how you can benefit from it.
By now, if you ever trusted in the Klever processes before, you already know that this is another secure and effective way to have a nice income from the crypto universe.