How can You Leverage the Advantages of Liquidity Pools

Traditional investment instruments: bank deposits, securities, and even precious metals have become less reliable and profitable in recent years. The recent global crisis and geopolitical problems have jeopardized the financial well-being of ordinary citizens.

That's why more and more people are trying to diversify their funds. Cryptocurrency has become one of the diversification options in recent years. Often its trend is inversely correlated with the global recession.

At the same time, there are more several prominent ways to diversify the funds within crypto rather than simply hodling them. These include participation in liquidity pools on DeFi platforms.

What are liquidity pools?

Liquidity pools are among the basic underlying principles for many decentralized projects. These include DEXes, lending institutions, gaming platforms, cross-chain bridges, and other blockchain projects.

The very idea of pools is fairly straightforward - these funds represent a large "digital mountain" or a reservoir of cryptocurrency funds. This is a cumulative repository of the user capital.

If we draw a simple analogy, then a similar warehouse of financial assets is a bank in which the savings of customers are stored. The bank uses this money at its discretion - issues loans, invests in various investment instruments in order to make a profit. Part of the income is deducted to customers in the form of interest on the deposit.

DeFi platforms function in a similar way. If we consider a DEX platform, traders operate with the funds coming from the liquidity pools.Thus, traders  always have funds for their operations. Similarly, liquidity is delivered to customers of exchange offices and credit platforms.

In addition, transactions are carried out according to algorithms specified by smart contracts on the blockchain - this is the key factor that guarantees the participants of the system strict compliance with the rules defined by the contract. 

The process of incentivization to the liquidity providers is called farming. Unlike mining, this method of operating with crypto assets does not require the purchase of specialized equipment and high energy costs.

All participants of the liquidity pool are paid remuneration in percent. These days DEX trading volumes are already approaching those on centralized CEX exchanges - these are daily volumes of tens of billions of dollars. DeFi ecosystems are rapidly expanding - new products and tools are being created to increase the efficiency of the underlying system.

Advantages and principle of operation

The main reasons for the popularity of liquidity pools on decentralized platforms:

• Attractive interest rates. As a rule, this indicator is higher than on bank deposits. However, it should be kept in mind that the value depends on many factors - the liquidity pool size, the demand for the token, and the popularity of the platform itself. In other words, the rate is floating, so the investor should monitor the market conditions and their deposits.

• Decentralization. DeFi-platforms do not have a centralized management body and intermediaries. The owners manage their wallets themselves, while the transactions are regulated by the smart contracts.

Liquidity pools in Allbridge Core

We would like to highlight one particular product that puts  on native liquidity pools - Allbridge Core, the new flagman product created by the team behind Allbridge Classic. Let's look at it in more detail.

Allbridge Core is a cross-chain swap platform that allows you to exchange dollar-pegged tokens (also known as stablecoins). But the main advantage of Allbridge Core is that it reduces perhaps the largest gap in the DeFi sector - the gap between EVM and non-EVM networks. The protocol already supports Solana, Ethereum, Tron, and BNB Chain, with more networks on the horizon.

In general, the platform offers significant improvements in user experience and makes cross-chain swaps as simple as one click of a button. On top of that, the user gains access to unique chains like Solana and Tron at very competitive swap fees.

How it works

Allbridge Core utilizes several messaging protocols to transfer the information between chains. One of them is Wormhole, a decentralized protocol operated by Jump Crypto, which is also used by their Portal Bridge. The other protocol is Allbridge's own messaging, which supports the chains that Wormhole doesn't (i.e., Tron). 

Allbridge Core has native liquidity pools for each supported token in each of the supported networks. Using the specified inter-network message protocol (Wormhole or Allbridge), virtual tokens are sent from the source network to the destination target network

Liquidity providers may participate in Allbridge Core pools with a preferred asset of their choice, while enjoying the proceeds from the protocol fees coming as the result of cross-chain swaps.

Possible risks

Like all financial instruments, liquidity pools have their own risks. The main ones are non-permanent losses and the danger of hacker attacks.

Smart Contract breaches are another force majeure situation from which no one is immune. To reduce this risk, platforms cooperate with reliable audit service providers, who access and review smart contracts.

Non-permanent losses are a multi-sided effect that occurs when the exchange rate of cryptocurrencies changes. In times of drawdowns, participation in the pool may be less profitable than holding. How to fight? Monitor the exchange rate - if you notice a persistent decline in the exchange rate, it makes sense to withdraw your assets until the situation improves.

Conclusions

Liquidity pools are a key factor sustaining many of the DeFi platforms. The owners provide their tokens to participate in various blockchain projects in exchange for monetary incentives. However, one should exercise caution when interacting with DeFi protocols and complete their own due diligence to prevent malicious attempts from bad actors.