I have been trying to learn more about crypto & finance in general to improve my knowledge. Can somebody explain how liquidity in the real world works?
1. What’s the liquidity process like?
2. Why do users need to provide liquidity on uniswap?
3. What happens to the money when a user provides liquidity to the pool?
Anything else, I highly appreciate it
In: Economics
Liquidity facilitates swapping of coins. If you want to swap AMPL to let’s say, AAVE, there has to be a liquidity provider for the pair. If there’s none, you can’t swap between the two and may have to swap your AMPL to another token first before you can swap to AAVE, sometimes, certain tokens have to be swapped to more than one token, depending on the availability of liquidity pairs.
Users don’t “need” to provide liquidity. They “can” for various reasons, mainly incentives. When you do provide a liquidity, you can choose any exisiting pair or create a new pair.
Let’s say you have provided liquidity for AMPL and AAVE on Uniswap. When someone else swaps their AMPL to AAVE or vice-versa, they pay a fee of which you have a stake, and the amount you will receive from the fee depends on how much tokens/coins you provide to the liquidity. Also, if someone else swaps from AMPL to AAVE, the liquidity amount of AAVE decreases while AMPL increases, so when you decide to withdraw your liquidity, the amount of tokens you get can be different from the initial amount you provided, meaning you can have more of either token while you will receive less of the other.
Hope that wasn’t too vague. There are many articles, videos and breakdowns out there you can read, give ’em a go.
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