Liquidity Provider

What Is a Liquidity Provider?

Liquidity providers are investors who place their cryptos in a liquidity pool to facilitate trading less mainstream coins on a platform and earn passive income through trading fees.  

Liquidity pools help to support trades on decentralized exchanges through what are known as Automated Market Maker (AMM) systems that support the trading of comparatively more illiquid trading pairs. Liquidity pools are a vital tool for decentralized exchanges (DEX). 

Trading between low liquidity trading pairs on exchanges without liquidity pools could cause losses due to wider variation and an inability to carry out trades. Liquidity providers offer the advantage that transactions are always executed, provided the liquidity pools are large enough to support the trade. As a result, liquidity providers are valued as trade supporters and earn income through the transaction fees that the platform charges for the trades that they helped facilitate.

A Source of Passive Income 

Users called liquidity providers (LP) pay the equivalent value of two tokens in a liquidity pool to build a market for the token pair. These liquidity providers earn from this through the trading fees that traders pay. The trading fee is distributed amongst the liquidity providers according to their contribution to the total liquidity pool.

The challenge of liquidity for less common or liquid currencies is dodged by using liquidity pools that support the trading pair and enable trades to occur. The payment of most liquidity providers is based on the amount of contribution they have in the liquidity pool. When providing funds to the collection, liquidity providers usually have to fund two digital assets to allow trades between one and the other by making trading pairs. For example, a liquidity provider may contribute $1000 each to BTC and TER to facilitate trades between the two. The liquidity provider will earn some income every time this pair is traded.