Have you ever wondered how you can make money in DeFi? Well, today I’m going to break down the first strategy, Liquidity Pooling, along with a strategy of how you can get started today!
In DeFi, traders provide liquidity to Decentralised Exchanges (aka DEXs). They operate like traditional exchanges, but are not affected by their weaknesses, such as lengthy transactions, high gas fees and slippage.
When traders lock their assets in a smart contract, a liquidity pool (LP) gets created. We can define a “pool” as the sum of at least two tokens locked in a smart contract that the exchange can pull from during exchanges.
For example, you can provide liquidity for pairs like AVAX-USDC. In order to provide liquidity, you need equal amounts of two tokens. If AVAX is $100 per token and you have 10 AVAX you want to pool, and USDC is $1 per token, you’ll need $1000 USDC.
You then “pool” these assets and get LP tokens, representing your pooled liquidity.
But why would traders do that? Because they’re rewarded for it.
By holding onto your LP tokens and providing liquidity, you earn an APY rate. Pooling APRs can range anywhere from 0.1% to upwards of 10k%. And these rates are reflected in how your pooled tokens grow.
So, you’ve read this far and you want in. Below is how you can get started today from scratch on a network I believe will have a great 2022, Avalanche!
- Open a Metamask Wallet and add the Avalanche Network to it (tons of videos about how to do this on Youtube!)
- Purchase some AVAX and put it into your wallet.
- Go to traderjoexyz.com, a major DEX on Avalanche that I recommend for best rates, and connect your wallet.
- Scroll through the “Pool” page to find a pair you’d like to provide liquidity for. ALERT: Just because a pair has a high APR doesn’t mean it’s a good pair — a major risk is impermanent loss, which is the risk that liquidity providers take in exchange for fees they earn in liquidity pools. I recommend you get started with something that isn’t as risky such as AVAX-DAI until you get more experience in DeFi (DAI is a stablecoin).
- For the rest of this example, I’ll use the AVAX-DAI and say I have 10 AVAX I want to put into a liquidity pool. Currently, the APR rate sits at 70% for this pairing.
- Go to the “Trade” page and swap 4.9 AVAX for DAI. Why 4.9 and not exactly half? Because there is a small fee included in swapping and pooling your assets — which are super low on AVAX and usually around 7 cents!
- Once you have approved this transaction through Metamask, you will see the amount of AVAX you have decreased and DAI appear in your wallet. Time to go swimming!
- Go to the “Pool” page and find the AVAX-DAI pair.
- Select the pair and click how much liquidity want to provide. In our example, you’ll hit “Max” when click on DAI. This will automatically add the matched amount of AVAX.
- Click on “Supply” and approve the transaction!
And you’re officially providing liquidity for the AVAX-DAI pair. But how do quantify your rewards? Record how much of each token is provided on the pairing. And record the current price of each token. This gives you you’re principle. Come back an hour or even a day later and record these again and compare the differences. That will give you your ROI.
A more technical post but I hope this helps anyone interested in getting involved in DeFi. I set up around 3 pools 4 days ago and have already made 14% ROI overall. Happy to chat 1:1 with anyone about this and my personal strategies for DeFi especially in bear markets!