What is Liquidity Provider?
Let's find out Liquidity Provider meaning, definition in crypto, what is Liquidity Provider, and all other detailed facts.
Liquidity providers are decentralized exchange users who fund a liquidity pool with tokens they possess. They do this to facilitate trading on the platform to earn passive income on their deposits.
A liquidity provider, for example, may supply a liquidity pool containing $8,000 worth of Ether and $8,000 worth of USD-pegged decentralized stablecoin DAI to facilitate the trading that takes place between the two. As a result, each time a trade on the ETH/DAI is made, the liquidity provider gets compensated for funding the pool in question.
So, the percentage of the liquidity pool they provide determines how much they will get paid. Typically, they are obligated to fund two separate assets when funding the pool, to allow traders to change between one another by trading them in pairs.
Decentralized exchanges employ automated market maker-based systems to facilitate the trading of illiquid trading pairs with minimal downtime leveraging liquidity pools. Rather than typical order book-based trading platforms, such exchanges employ money for each asset in each trading pair to permit deals to be performed.
Although trading illiquid trading pairs on order book-based exchanges may result in significant dislocation and failure to finish transactions, liquidity providers' benefit is that trades may always be performed as long as the liquidity pools are large enough. As a result, liquidity providers are regarded as trade enhancers and are compensated through service fees charged from their facilitated trades.