Providing Crypto Liquidity: What Does Liquidity Mean In Crypto

The following guide walks readers through our own experience providing crypto liquidity to different protocols. It also explains how providing liquidity varies on different blockchains. Lastly, it breaks down the process step by step so readers will be comfortable providing liquidity on their own.
Lead Writer
Matt Pearlstein
Matt Pearlstein
Analyst

Introduction To Crypto Liquidity

What is Liquidity?

In short, liquidity measures how easily an asset can be converted into cash, without losing a significant amount of its value. And when it comes to crypto, liquidity is king.

That’s because it helps to keep asset prices stable and provides confidence to holders that they will be able to exchange their assets when they choose to.

Why is Crypto Liquidity Important?

An asset is only worth what you can exchange it for, and without proper liquidity it can be difficult to maintain its full value. 

Sufficient liquidity:

  • Ensures better prices for traders by decreasing the slippage on every swap.
  • Helps keep asset values stable and allows a large amount of volume to trade.
  • Makes transacting quicker and more efficient by always having buyers and sellers queued.

How To Earn Yield As An Liquidity Provider

With centralized exchanges, liquidity is provided by professional trading firms and market makers. Market makers offer up a bid and ask price at all times for an asset, creating an ongoing market for it.

In the case of decentralized exchanges, liquidity is provided by liquidity pools. Since liquidity provider’s (LPs) are allowing traders to use their funds, they receive a slice of the trading fees and generate a return over time.

And in the decentralized world, anyone with a wallet can become a liquidity provider (LP) and contribute to pools. So we jumped in and provided some liquidity with the public wallet. 

What We Did: Liquidity Provision On Different Blockchains

We provided our funds to liquidity pools on three unique protocols across DeFi. We wanted to show Roaders two things:

1/ The process of providing liquidity to different types of protocols.

2/ The difference between providing liquidity on different blockchains.

As a result, we did the following:

  • Locked up ~.1 ETH and ~160 DAI in a liquidity pool on Uniswap (Base chain)
  • Provided ~.15 ETH as liquidity to Stargate Finance’s bridge on Optimism
  • Deposited .125 ETH and 255 ARB into a Camelot DEX liquidity pool on Arbitrum

Provided Liquidity To Uniswap On Base Chain

Uniswap is the OG decentralized exchange (DEX). It was the first DEX to pair tokens with ETH and kicked off a massive DeFi boom in 2020 upon its launch.

Since it is so popular and seasoned, we are more comfortable locking up our tokens in the protocol’s smart contracts. Additionally, they were quick to integrate Base’s chain where we recently bridged funds to.

Note that providing liquidity to a DEX requires depositing both sides of the pair. Instead of just locking up one asset in a pool, you have to lock up equal amounts of two assets in a trading pair. As a result, we swapped .1 ETH for ~160 DAI before providing liquidity.

Lastly, providing liquidity on Base only cost us a fraction of what it would have cost on Ethereum, due to Base being a layer-2 blockchain. For all 3 of our transactions we were able to transact with only a small amount and not worry about fees hurting our yield.

Provide Liquidity to Uniswap on Base Chain

Provided Liquidity To Stargate’s Bridge On Optimism

Providing liquidity to Stargate is very similar to Uniswap. The only difference is our assets earn fees from users bridging instead of swapping.

Provide Liquidity to Stargate’s Bridge on Optimism

We chose Stargate for a few reasons:

  • Since we are not providing liquidity to trading pools, we only need to deposit one asset into the protocol
  • The protocol is powered by Layer Zero, who is widely expected to conduct an airdrop with Stargate being a potential qualifier
  • The bridge has seen a lot of volume recently in anticipation of the airdrop. The more volume that goes through the bridge, the more fees LPs receive.

Provided Liquidity To Camelot DEX On Arbitrum

Camelot is a DEX just like Uniswap but is unique for several reasons. First off, Camelot is a DEX native to Arbitrum’s network, while Uniswap is deployed on several and counting.

Camelot also has a lot less funds locked on its platform. And while that may make the protocol more risky, the yields for the liquidity pools are also higher.

The other difference with this position is that we opted to lock our funds for 30 days. Note that this adds a considerable amount of risk and we are just messing around and trying things with the public wallet. But, by doing so we were able to score a ~16% boost on our yield.

Provide Liquidity to Camelot DEX on Arbitrum

Since the ARB/ETH pair was offering a high return range of 8-17.7% and we wanted to add another asset into the public wallet, we swapped for some ARB to pair with ETH for this position.

Keeping Up With Our LP Positions

Once you provide liquidity to a pool, you receive a tokenized receipt known as a LP token. These tokens represent the underlying assets you have locked up on the protocol, as well as the accrued rewards for doing so.

There are two main ways to track these positions:

1/ Through the protocol: You can view your positions within the protocol’s themselves by connecting your wallet.

Keeping Up With Our LP Positions

2/ DeBank: Portfolio trackers like DeBank present LP and other positions in an attractive way.

DeBank portfolio tracker

Step By Step: How To Provide Liquidity To Uniswap

Part 1: Getting Started With Uniswap

When are arrive at Uniswap, you will need to navigate to “Pools” at the top. If you have any LP positions open, they will appear here. If not, you will need to select “new position” from the pink bubble:

Providing Liquidity on Uniswap

After initiating a new position, you will see this popup screen:

Uniswap crypto liquidity
  • First you need to select two assets to pair together as a trading pair, this is done in the same way you choose assets to swap on Uniswap.
  • Fee tier allows you enter different liquidity pools based on fee %, they provide context below on the recommended fee tier based on the type of crypto asset.
  • Set price range is optional and is an advanced feature. This allows you to provide your liquidity to a defined price range of the underlying asset only and helps to prevent impermanent loss.

After filling out this screen, you will just need to choose the amount and confirm the transaction. Doing so is very similar to engaging with a DEX or other DeFi protocol:

crypto liquidity on different protocols

Concerns Around Providing Liquidity

While providing liquidity can generate an attractive return, return does not come without risk. Here are some of the risks you should be aware of:

  • Smart Contract / Provider Risk: Depositing assets removes them from your personal wallet and puts them in the hands of a smart contract or an entity. This opens users up to the risks of exploits or mispractice.
  • Impermanent Loss: Impermanent loss is a concept similar to opportunity cost and refers to an instance where you would have been better off holding your assets instead of providing liquidity. This is due to the way that liquidity pools function, which you can read about here if you’re interested!
  • Unpredictable Yield: The yield from providing liquidity can be hard to predict and is constantly changing.

Next Steps

Next week we are going to dive into perpetual futures and learn about the evolving topic of “real yield”. We will do so by opening and tracking a few trades, as well as diving into some innovative protocols on Arbitrum.

For now, readers can track our wallets on their own through DeBank. Simply go to their site, paste in our wallet address and follow our journey in real-time under “portfolio”. 

Here is the Milk Road Public wallet address:

0x455419210c0E31cC1aDEF14e1c8db81f1Dc80A83


This report is for informational purposes only and should not be relied upon as a basis for investment decisions, nor is it offered or intended to be used as legal, tax, investment, financial or other advice. You should conduct your own research and consult independent counsel on the matters discussed within this report. Part performance of any asset is not indicative of future results.

It should also be noted that the writer(s) of this report may hold assets mentioned in the article at the time of writing.

Matt Pearlstein
Matt Pearlstein
Analyst
Matt found crypto in 2016 and left TradFi to go full time in the industry a few years back. He is deep in the weeds of DeFi and also likes to go to the beach and play basketball.

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