In this article we are going to see the options we can find in the DEX regarding the contribution of liquidity in order to draw conclusions about the most attractive one. We currently have the well-known traditional Liquidity Pools, the recent novelty of Concentrated Liquidity launched by Uniswap and the Spacedex liquidity vaults.
WHAT IS A LIQUIDITY POOL?
A DEX does not use an order book to carry out exchanges rather, it works thanks to liquidity pools, where users can contribute liquidity to the platform receiving in exchange a part of the commission of 0.3% each time a trader makes use of the DEX. A liquidity pool is always made up of two tokens, for example ETH/USDC. Usually, the liquidity provider has to contribute the two tokens in the same proportion: in the ETH/USDC pair, if 1 ETH is trading at $2,000, the LP will be 1ETH/2,000USDC.
So, let’s imagine that ETH is represented by x and USDC by y. The protocol multiplies them together and obtains a total liquidity reserve represented by k, so the final formula would be x*y=k. Here the most important thing is the function of k: to stay constant at all times. This means that if the user Juan decides to buy 0.5 ETH for 1000 USDC using that liquidity pool, the USDC will increase in the reserve and the ETH will decrease. So, the price of Ethereum will go up. This mechanism is what determines the prices without the need to have an order book as in centralized exchanges.
WHAT IS CONCENTRATED LIQUIDITY?
Concentrated liquidity is liquidity allocated within a custom price range. Previously, liquidity was distributed between 0 and infinity, evenly along the price curve.
V3 allows liquidity providers (LPs) to concentrate their capital in smaller price ranges. The rising and falling asset prices can go outside the limits set by the LPs. When this happens, the liquidity of the position is no longer active and it no longer generates commissions. This offers traders greater liquidity and allows LPs to earn more with less capital investment. Concentrated liquidity allows the market to decide a sensible distribution of liquidity while allowing LPs to create as many positions as they see fit in their price range.
UniSwap V3’s customizable LPs, along with single-sided asset provisioning, open up new features to complement market orders called “Remote Orders”.
This means that the liquidity provider is bound to become professional and keep up with the exchange activity if they want to improve their profits. In addition, your position on Uniswap will now be unique and will be represented by a non-fungible token (NFT).
This new version makes it possible to greatly optimize the capital provided by liquidity providers and rewards those who know how to find the right range at the most suitable time in the market.
For example, you can create an ETH/USDC liquidity pool with the price range of $1,500 to $2,000, the more that range is concentrated, the more your profits are.
If it falls out of your range, you are automatically accepting a loss since your position becomes one of the totally inactive ones. If your LP is ETH/USDC and Etherum breaks out of the range below, the protocol automatically liquidates your ETH and transforms it into USCD.
If we break out of the range to the downside, the protocol will sell all of our USDC and we will hold a 100% position in WETH until the price ranges reverts again. Conversely, if we break out to the upside, the position will be 100% USDC. This solution is efficient in terms of the profitability that your liquidity generates but it also forces you to have trade positions, accepting a loss or gain if the price leaves your range.
What does Space Dex offer to liquidity providers?
An innovative protocol that works through liquidity deposits (Vaults).
Through this protocol we can provide liquidity directly in 1 of the tokens that are within the protocol, in this way, if for example we are working in the BSC network, we can contribute BNB and receive an LP (FalconLP in the case of SpaceDEX), this would be a token representative of the liquidity contributed, let’s say as an example, we contribute to the protocol 1 BNB that has a value of $300 and the total value of the deposits at that moment is $3,000,000, at that moment we will receive enough FalconLP to represent the 0.01% of the total of FalconLP at that time (as the liquidity contributions in the deposits increase or decrease, that percentage will vary). If there were no changes in the prices of the tokens in the deposits, by burning those FalconLP, you would receive $300 in any of the tokens you choose from those in the vaults.
If the value of the deposit tokens will increase by 10%,
By burning the FalconLP, you would receive $330 in one of the tokens in the deposits you choose.
If the value of the deposit tokens decreased by 10%
By burning the FalconLP, you would receive $270 in one of the tokens from those in the deposits of your choice.
The Fees generated by swaps and lending are distributed in BNB to FalconLP holders proportionally according to the percentage of the total LPs that each user has, being able to claim and send those BNB to their wallet at any time.
In this protocol, the liquidity provided is used for lending and swaps, where users can make use of it by leveraging their positions or exchange from token A to B (swap) without any impact on the price.
Obviously, the value of the vault depends on the tokens that makes it up. In the case of the starting BSC network, it will be made up of BNB-BUSD-WBTC-WETH, so the impermanent loss has a much smaller impact in terms of the value of the liquidity provided, since the tokens with the highest volume and market value are chosen from the start, with historically low differential movements in their price. It should also be noted that the efficiency of the protocol in the use of liquidity is maximum, since in this situation not only fees from swaps are generated but also lending fees, for leveraged operations.
All this means that providing liquidity to this new protocol is very advantageous, since the liquidity is backed by liquid and stable assets and is also continuously in use, increasing the commissions it generates.