So a few days back @mistural asked me for how to add liquidity to the swap.hive:lvl liquidity pool. I tried my best explaining,but couldn't really break it down well enough in dm, so I decided why not make a post about it explaining everything. So in this post I'll be explaining the concept of liquidity pools, telling you the benefits and risks involved with adding liquidity. The video above shows how to add liquidity to hive-engine tokens using beeswap
What is a liquidity pool?
As we all know, when you want to buy or swap a token on a conventional exchange, you enter the amount we want to swap and the price you are willing to pay for it. Then you have to wait until someone else who's trade corresponds with yours arrives before being able to make the trade.
Now in order to reduce that stress of waiting, liquidity pools were created. A liquidity pool is a smart contract that contains equal amounts of two tokens in a 50:50 ratio (it can be more than two, but I don't know much about those). The reason those two tokens are there is so that whenever you want to buy or swap between the two tokens, you don't need to wait for someone else to be available before making those swaps. For each transfer or swap you perform you are charged a small fee, called transaction fees.
Note that since they are in 50:50 ratio, the more you buy one token the more expensive it becomes, and the less expensive the other one becomes,such that the ratio of both tokens in the pool is always 50:50.
Why should I add liquidity?
Yes, so for each transfer done on that liquidity pool, a small fee is paid. Now when several people do transactions on that liquidity pool the fees are accumulated and shared among those who added liquidity according to how much they added to the pool. Other than those, some liquidity pools add extra rewards like other tokens that are shared among those who add liquidity. A lot of hive-engine liquidity pools do this.
Risks involved in adding liquidity
There are two major risks involved in providing liquidity. The first one is
Impermanent loss: This is when you would have made more profit or less loss if you had just held the tokens rather than providing liquidity. This can occur under different circumstances.
the price of one token rises and the other dips. (you'll lose a lot of money quickly when this happens)
the price of one rises and the other remains the same. (you gain profit, but it would have been more if you had just held)
the price of one dips and the other remains the same. (you would have made a loss if you held, but it wouldn't have been this much)
The greater the deviation from the original price, the greater your impermanent loss will be. If they both rise or drop at the same rate. There'll be no impermanent loss.
Note it's called impermanent loss because it can be corrected if the price goes back to how it was when you bought it. As long as you don't withdraw it's still impermanent, but once you do it becomes permanent.
Rugpulls:This one is quite common nowadays. This is when the owners of the token remove all the liquidity from the pool and flee. All those who hold the token, as well as those who provided liquidity lose everything.
Note that you can always remove liquidity at any time.
I hope with this little I've written, I've been able to make you understand even a little bit about liquidity pools. Thanks for reading.
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