DeFi Liquidity Pools: What Are They & How Can You Make Money With Them?

DeFi liquidity pools are a great way to make your cryptoassets work for you, generating additional revenue streams. Many DeFi functionalities critically depend on these pools, so they tend to reward liquidity providers pretty well for filling this need.

In this guide, you’ll learn about DeFi liquidity pools, how they work, and how you can use them to earn crypto on Sovryn.

Liquidity pools are smart contracts that hold locked cryptoassets to enable trading, lending, and other activities on DeFi platforms while rewarding you for contributing to these pools.

‍In DeFi, liquidity is provided by users rather than a central entity or exchange, enabling near-instant swaps, trades, and loans. 

Without this liquidity available, you would have to wait for someone else’s bid/ask order to match yours to complete a trade. This can take a very long time, making it very impractical.

Liquidity pools fill this need. You can join other liquidity providers and lock up your assets that are then used to facilitate these trades and loans. It eliminates long waiting times and provides you with a percentage of the fees as a reward.

DeFi liquidity pools work by having users who are liquidity providers (LPs) lock up their tokens or assets for an amount of time and receive a percentage of the fees back as a reward. 

When you first lock up your assets, you typically get LP tokens in return that represent your share in the pool and can be redeemed back for the amount you provided.

Liquidity can be provided on a double-sided (more common) and single-sided (less common) basis. 

• Double-sided means you provide both the tokens that make up a liquidity pool at the same ratio, which ensures no one token is ever overrepresented and makes up too much of a pool. 
• Single-sided means you only provide one token of the pair, whichever you prefer, but this is a less common option so you may not find it everywhere and for every token.

One potential risk of providing liquidity for these pools is called divergence loss. This is the inferior performance of your assets as they get continuously rebalanced in the pool to a 50/50 value compared to simply holding them without rebalancing. The rewards and fees that providing liquidity will generate for you can offset this loss. However, you should always be aware of this potential for loss when making a decision.

DeFi liquidity pools are looking to increase liquidity, so you can make money by providing this liquidity to them. It’s actually pretty easy when you know where to start! 

In this example, we’re using Sovryn’s dapp and its market making feature that allows you to earn fees from AMM (automated market maker) swaps. 

First, visit the Sovryn dapp. Connect your wallet by clicking on ‘Get Started’ in the top right corner of the page. 

Then, click on the ‘Earn’ option and find ‘Market making’ in the dropdown menu, and click on that. 

The liquidity pools you’re shown will depend on the network; in the upper right-hand corner, switch from Rootstock (RSK) to Build on Bitcoin (BOB), depending on the assets you want to provide. 

On RSK, you can provide different assets like DLLR, SOV, RUSD, and similar on a double-sided basis. On BOB, you can lock up your Runes in addition to other assets.

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Then, choose the pair for which you want to provide liquidity. 

The platform will let you know how much is already locked in that pool, how much APR you can get for providing liquidity, what the pool’s 24-hour volume is, and how much you’ve already locked up, if any. Rewards recalibrations happen on a regular basis, and the platform shows the next date, so you know when to expect the terms to change.

When you click ‘Deposit,’ you’ll be able to enter the amount you want to provide for one asset, with the other side of the pair autofilling. 

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Keep in mind you’ll need a small extra amount of BTC to create and confirm the contract. 

When you’re happy with the terms, click on ‘Confirm,’ and your rewards should start accruing soon!

If you’re looking for the perfect place to get started with providing liquidity to DeFi liquidity pools, Sovryn is the place for you. 

With plenty of different pools and pairs over two different networks, high APRs, and extra incentives and rewards, plus a straightforward way to get started, Sovryn is equally suited for newbies and experienced users. Plus, its decentralized nature means your funds are always yours alone.

‍Connect your wallet to Sovryn to start exploring liquidity pools and market-making options.

Are DeFi liquidity pools safe? 

DeFi liquidity pools are usually safe, since their security is ensured through stronger decentralization and smart contract code. However, there are some risks associated with this: for example, the smart contract code can be faulty, letting malicious actors take advantage of previously unrecognized issues. Additionally, the value of the liquidity you’ve provided can fall compared to the time when you first locked it up, leading to divergence loss. It’s key to do your own research before committing to any pool.

What is better, staking or a liquidity pool?

Staking and liquidity provision are two different activities that can’t always be compared. Staking is great for people who hold a token that can be staked, letting them earn rewards and participate in the governance of a network. Liquidity pools, on the other hand, don’t have this sort of responsibility, as their main goal is to provide liquidity for a DeFi platform. Moreover, in this case, you’ll usually need to provide two different assets at the same time. 

Does Bitcoin have a liquidity pool?

While Bitcoin itself doesn’t have a liquidity pool because it’s a blockchain, network, and cryptocurrency, not a DeFi platform, there are liquidity pools where BTC makes up one side of the pair. You can find some of these on Sovryn, plus a number of pools with BTC-based tokens and assets as pairs. Usually, DeFi platforms will have liquidity pools for any asset that users need on a supply-and-demand basis.

What is the primary goal of liquidity pools in DeFi?

The primary goal of liquidity pools in DeFi is ensuring that decentralized finance platforms can operate smoothly and provide all the needed liquidity for their users, for example, without having to wait for bids or ask orders to fill every user’s needs on a decentralized exchange. This ensures faster processing times.