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The Advantages and Disadvantages of Liquidity Pools

One of the most common uses of cryptocurrencies is, of course, forex trading. 

This is what attracts economic enthusiasts to crypto. As opposed to fiat, coins and tokens are volatile, which means you can get huge profits in a matter of hours. 

However, when you deal with actual people, it’s hard to know what to expect – the value of an asset is different for each of us.

That’s why the launch of DeFi and thus Liquidity Pools were met with such enthusiasm. 

But, like any other technology, Liquidity Pools have their ups and downs. Before you choose to sign in for an exchange platform, make sure you take all of them into consideration.

The advantages of Liquidity Pools

  1. You don’t make trades; you make exchanges 

The biggest advantage of LPs is that you don’t need to worry about whether or not you will find a partner that sees in crypto the same value as you. 

If you traded crypto before, you probably encountered users who want to sell their crypto for excessively high prices or who want to buy your crypto for low prices. In order to win out, you need excellent negotiation skills and strength of character. Not everybody has these. 

Liquidity Pools, however, adjust the value of cryptocurrencies based on the exchange rate on the platform. 

On crypto exchanges, users don’t get assets by trading. They borrow assets from a pre-funded liquidity pool. These are generated from the exchange rates, so it is a cyclical process. 

  1. Low Market Impact

Now that there are no sellers who demand double the market price or buyers ready to devalue it below average, the transactions are a lot smoother. 

A Liquidity Pool is a collection of funds locked in a smart contract whose values are updated automatically depending on the exchange rates. 

The disadvantages of Liquidity Pools

  1. The AMM may reduce your assets’ value

The Automated Market Makers keep the DeFi ecosystem liquid via liquidity pools. These allow cryptocurrencies to be traded without permission, using a simple formula: 

Token A balance x Token B balance = The constant balance of assets 

When A goes up, B goes down. Therefore, if the purchasing power of an asset is too big, you may be at a loss if you don’t own it already. This is called an impermanent loss.

  1. A simple bug can lose your funds forever

Since there are no third parties in Decentralized Finance, the custodian of your assets in the pools is the Smart Contract. If something happens to it, your funds will go down too. 

But what is a game without some risk? If you really want to make a profit out of crypto, you should go for these big opportunities. Otherwise, you’ll be stuck with fiat forever.

MubaShar Nawaz (United Arab Emirates)

MubaShar Nawaz is an experienced crypto writer working for Tokenhell. Having passion for writing, he covers news articles from blockchain to cryptocurrency.

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