DeFi Kingdoms for Commoners #2: Introduction (Liquidity Pools)
Hello, reader! DeFi Kingdoms for Commoners series is written for audience who have little to no experience in the world of cryptocurrency. My main goal in writing this is to provide in-depth information about DeFi Kingdoms in simpler terms. This is the second installment of this series, feel free to navigate around my profile to read on the previous one. Happy learning!
What is DeFi Kingdoms?
DeFi Kingdoms is a game, a DEX, a liquidity pool opportunity, a market of rare utility driven NFTs, and it all plays out seamlessly in the incredibly nostalgic form of fantasy pixel art. It is launched on Harmony Network.
In this article, we are answering one question: What are Liquidity Pools?
A liquidity pool is a collection of funds locked in a smart contract. Smart contracts were discussed at the last installment, so if you are still unaware about its purpose, be sure to check it out.
Liquidity pools are responsible in facilitating mainly for decentralized trading, lending, and many other possible functions. Instead of the traditional way of buyers and sellers in the market, decentralized exchanges use automated market makers (AMM) for cryptocurrencies to be traded automatically. Liquidity pools are a mechanism in which holders can pool their assets to a Decentralized Exchange’s (DEX) smart contracts to provide asset liquidity for people that want to swap between any cryptocurrency (for example, BTC-ETH pair).
Out of all markets in the world, cryptocurrency is the one that needs liquidity the most. Slippage is always a concern when trying to execute a trade. Liquidity pools solve the problem of illiquid markets by rewarding the users that provide liquidity for a share of trading fees.
Slippage is the difference between the expected price of a trade and the price at which it will be executed. Trading at low liquidity, highly volatile assets will usually result to a high slippage. Slippage is also bound to increase at large orders with small volume from the bid and ask side.
In much simpler terms, imagine a basket with two apples and two oranges. Person A wants to buy two apples using two oranges, leaving the basket with zero apples, and four oranges. Person B comes, with a handful of oranges, with the intent of buying apples as well. Now, he cannot buy them because there are no apples left in the basket. This is the purpose of liquidity pools, to make sure that there are enough volume between two cryptocurrencies (or in this case, fruits), so swaps can be made possible.
To create a better experience, various platforms specify particular pools that they incentivize. Yield farming is the practice of staking tokens in order to receive the tokenized rewards to improve the earning potential of providing liquidity. In other words, you are lending your cryptocurrency in exchange for interest and fees. It brings an excellent potential of earning passive income.
However, every investment has its own risk. The volatility of the cryptocurrencies affect how liquidity pools work. Impermanent loss happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them. The bigger this change is, the more you are exposed to impermanent loss. It is further explained in this article and video.
DeFi Kingdoms Liquidity Pools
The Gardens is where you can access the yield farming through liquidity pools aspect of DeFi Kingdoms. The Seed Box is where you put your seeds (in-game term for liquidity pool tokens) and Harvest is where you can claim your rewards in JEWEL (DeFi Kingdoms’ main currency).
For more information with regards to staking liquidity pool tokens and farming, please refer to this Medium article.
I am a crypto noob but I am interested. How do I start?
You can start by making an account in a Central Exchange (Binance, Crypto.com, Kucoin, or just ask your crypto friend), then create a MetaMask wallet. Stay tuned for the next installment of this series.