📈 What is liquidity provision and how can you profit from it?

Since one of today’s main ecosystem news is the distribution of commissions on DeDust.io, we decided to talk about liquidity pools as part of our educational series #howtoton.  If you have long wanted to understand the topic, this post is for you.

⚫️ A key part of every blockchain is decentralized exchanges (DEX) — platforms where you can connect your non-custodial wallet to buy or sell nearly any token in the network. Each of these tokens is paired on the exchange with another popular coin (on TON, this is usually Toncoin or USDt).

⚫️ A liquidity pool is a kind of storage of funds for each token pair. When you make a trade, you add one token to this storage and take another out of it for the same value. The token price changes based on the type of transaction: it rises if you bought a coin and falls if you sold it — hence the price fluctuations.

⚫️ But where do the tokens in liquidity pools come from? On DEX, liquidity is provided by users themselves (both token creators and regular holders). Liquidity Providers (LP) deposit two tokens of equal $ value into the pool to receive LP-tokens in return, which gradually increase in value through reinvested fees.

⚫️ In this way, liquidity providers «fill up» liquidity pools with their assets so that other users can easily buy and sell the tokens they’re interested in. The exchange collects fees, which are then distributed proportionally among the LPs. Sounds like a win-win?

⚫️ Not entirely. The main challenge for liquidity providers is impermanent loss: if the price of the tokens you’ve invested changes drastically, you may lose some value in dollar terms. Therefore, sometimes simply holding tokens can be more profitable than investing them in liquidity pools.

⚫️ This is why exchanges introduced boosts and farming — additional rewards to motivate users to provide liquidity despite the risk of impermanent loss. If you’re lucky enough to invest in a pool with high trading volume and generous boosts, the reward can more than cover any potential losses.

@thedailyton