Guide to Crypto Farming (part 1)

Introduction to liquidity pools and farming

In any market the first problem you need to solve is liquidity, for example if you go to your local market to buy tomatoes you need two things to be present on the shop:

  • they have tomatoes
  • they have change

So the solution is to bring enough amount of both sides of the trade into the market so both merchant and consumer can do their trade, this is called, liquidity

  • liquidity provider add liquidity putting 2 tokens into a pool (3000 Orion and equivalent value in ETH)
  • then a user buy Orion with ETH
  • Liquidity provider wants to get his tokens back
  • when the swap happened, the supply for orion is less than eth
  • this causes the price of orion vs eth to go up
  • when the liquidity provide wants to get his tokens he get’s less orion and more eth

If one token of the pool goes up in price it’s supply decreases on the pool and I can get less value than someone who was holding both tokens, this is called IL (impermanent loss)

So, why people participate on LP (liquidity pools) then?

In traditional CEX the fees are just earned by the exchange, in DEX is shared across all liquidity providers, it’s a more fair distribution of wealth which is aligned with the defi paradigm (decentralized finance)

But even with that it can happen that the fees are not covering full IL which leads to the next 2 points:

Conclusions

  • Liquidity pools are a more fair wealth distribution system
  • They have a risk of IL (impermanent loss)
  • Fees + farming mitigate previous risk
  • It’s a passive income investment and need long term to be profitable
  • farming: where to start (ready for reading)
  • how to manage your rewards (coming soon)
  • risks (coming soon)
  • how to optimise your farming rewards (coming soon)

You can follow me on Twitter: @crypt_stylo

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Crypt Stylo

Crypt Stylo

White hat crypto trader / full stack developer