How does Liquidity Peers earn from Automated Market Making (AMM) in crypto industry?

Updated: Oct 11, 2021

In the crypto-verse, automated market making (AMM) and liquidity providers has changed the DeFi game. Find out which companies has used this to build their ecosystem.

 


Automated market makers (AMMs) are an integral part of the decentralized finance (DeFi) ecosystem. They enable trading digital assets automatically with the help of liquidity pools. AMMs have made their mark in the DeFi space due to their simplicity and convenience. Decentralized market-making or automated market-making plays an important role in making cryptocurrencies the future of finance.


Automated market makers allow traders to become liquidity providers. They offer a share of transaction fees and liquidity pool tokens. Traders are able to earn not only by trading but also by becoming liquidity providers. Let's see how automated market making works and the benefits in becoming a liquidity peer.


What is automated market-making?

To simply put, the automated market maker is an underlying protocol that powers all the decentralized exchanges. They are autonomous trading mechanisms that remove traditional market-making techniques. AMMs have smart contracts (self-executing programs) that are programmed to find out the prices of digital assets and create liquidity.


Decentralized exchanges (DEXs) eliminate the need for intermediaries in crypto trading. They are completely opposite to centralized crypto exchanges where all the private keys are held by the exchange. There is no custodial infrastructure and support order matching systems with DEXs. They are able to avoid traditional order matching systems only with the help of automated market makers (AMMs).


How does Automated Market Marker (AMM) work?

AMMs use preset mathematical formulas to discover the prices of paired tokens. AMMs allow any trader to become a liquidity provider by providing funds to the paired assets.


Liquidity pools exist on AMMs and they are similar to the trading pairs one can find in a centralized exchange. If a trader wants to trade Ethereum ($ETH) for Tether ($USDT), he needs to find an ETH/USDT liquidity pool.


Unlike having dedicated market makers in the traditional financial platforms, anyone can become a liquidity peer by depositing both the assets in the liquidity pool. A trader needs to deposit a predetermined ratio of ETH and USDT to become a liquidity provider for an ETH/USDT liquidity pool.


AMMs use predefined mathematical formulas to ensure the assets in liquidity pools remain balanced. They help in eliminating the discrepancies in the pricing of pooled digital assets. For example, the Uniswap DeFi protocol uses the mathematical formula x*y = k. In this formula, x is the value of asset A, y is the value of asset B, and k is constant.


Uniswap liquidity pools always make sure that the multiplication of the prices of asset A and Asset B equals the same number. Let us apply the ETH/USDT liquidity pool scenario here. When a trader wants to purchase ETH, he needs to add USDT to the pool to remove ETH from it. Then the amount of ETH decreases in the pool and causes an increase in the price of ETH to balance the formula x*y = k. The same procedure applies when USDT is removed from the pool by adding ETH.


Uniswap uses a simple mathematical formula. But other protocols like Balancer, Curve use complex mathematical formulas to balance the prices of paired digital assets. Balancer enables its users to create a liquidity pool that combines 8 digital assets in a single pool. Whereas, Curve uses a formula that is more suitable for pairing stablecoins.


When large orders are placed and a large amount of a token is removed from the pool, there will be a significant increase in that token’s price. In these kinds of scenario, a trader can earn from arbitrage trading. Arbitrage trading involves buying a token from a liquidity pool at a lower price and selling it on external exchanges at a higher price.


How liquidity peers can earn using AMM

Automated market makers need funds or tokens to function properly. If a liquidity pool does not have enough funds, it is likely to have slippages. To eliminate this problem, AMMs encourage traders to become liquidity peers by providing funds or digital assets to the liquidity pools.


In exchange for providing their funds, liquidity peers can earn a fraction of trading fees whenever a trade happens in the liquidity pool. Besides getting a share in each transaction fee, liquidity providers will also have a liquidity pool token (LP token). If their deposits represent 1% of the liquidity locked in a pool, then the liquidity peer will get an LP token that represents 1% of the accumulated transaction fees of that pool.


Liquidity peers also have the flexibility to exit from the pool. By redeeming their LP token, they can receive a share of the transaction fees. Any trader can become a liquidity provider or liquidity peer in an AMM and earn fees.


XanPool’s Liquidity Peer Program

XanPool enables users to become liquidity peers with the help of its liquidity protocol. The secure platform does not take custody of its liquidity peers’ funds, unlike traditional crypto trading platforms. Users also do not need to deposit a market maker fee to become a liquidity peer on XanPool. They can earn their fees directly from the market takers a.k.a the customers of XanPool.


One of the unique features of XanPool is, it enables users to make crypto purchases in local payment methods. It is currently available in several Asian countries like Malaysia, India, Thailand, Hong Kong, Vietnam, Philippines, Indonesia, New Zealand, Australia, Singapore, etc. Those who live in these countries can become liquidity peers on XanPool and purchase tokens using their local payment methods.


The platform avoids an extra layer of conversion to purchase any altcoin. Liquidity peers of XanPool can purchase and sell any altcoin directly without converting it into another crypto coin using their local currency. XanPool allows its users to access their funds instantly and there will be no delay while withdrawing as well.


Are you wondering how to become a liqudity peer on XanPool? Sign up here!