In this article, you will learn what a liquidity pool (Constant Product Pool) is and why no DEX can function without one. You’ll also discover the nuances of providing liquidity on STON.fi.
What Is a Liquidity Pool?
A liquidity pool is a cryptocurrency reservoir that contains two assets. The total value of both assets in the pool is equal.
For example, in a TON/USDT liquidity pool, the total value of TON and USDT must be equal in monetary terms. This means if there’s $6 worth of TON in the pool, there must also be $6 worth of USDT, regardless of the quantity of each asset.
Why Are Liquidity Pools Necessary?
Liquidity pools are essential for automated trading (AMM).
When token swaps occur on an AMM DEX, such as STON.fi, the assets you receive come directly from the liquidity pool for that pair, while the assets you provide are added to the liquidity pool. This enables automated trading.
Liquidity pools also calculate exchange rates based on token ratios.
Example:
If the pool contains 1 TON and 6 USDT, the rate is calculated by dividing USDT by TON (USDT/TON), resulting in 1 TON = 6 USDT.
Conversely, 1 USDT = 0.1666 TON.
This is how exchange rates are determined during swaps on AMM DEXs.
Liquidity pools allow trades at any time without needing to find a buyer for your tokens, as is required on centralized exchanges (CEXs) with order books. Instead of interacting directly with a buyer, you interact with a liquidity provider and a smart contract.
Why Provide Liquidity?
By providing liquidity, you earn fees from trades in the corresponding pair.
On STON.fi, the transaction fee is 0.3%, with 0.2% going to liquidity providers and 0.1% to the platform.
When you provide liquidity, you receive LP tokens, which are displayed on the pool page. These tokens serve as proof of your liquidity provision. If farming (Farm) is available in your liquidity pool, you can stake your LP tokens to earn additional rewards.
Guide: What Is Farming?
How to Farm on STON.fi?
Want to Provide Liquidity?
Go to the “Pools” section on STON.fi.
There, you will find the largest number of liquidity pools on the TON blockchain. Remember, to provide liquidity, you’ll need equal value in both tokens.
Need help?
Here’s a guide on how to provide liquidity on STON.fi.
Pitfalls of Providing Liquidity
Fees:
When providing liquidity on STON.fi, blockchain fees (0.05–0.3 TON) and platform fees (0.3%) are charged for each token.Impermanent Loss:
Impermanent loss occurs when the value of one or both tokens in the pool changes significantly after you’ve provided liquidity.
Example:
Imagine a TON/USDT pool where you’ve provided liquidity in the form of 10 TON and 50 USDT (totaling $100). The current rate is 1 TON = 5 USDT, and your liquidity represents 10% of the total pool liquidity (100 TON/500 USDT).
Over time, the price of TON increases to 20 USDT per TON.
Due to this 4x increase, the pool’s assets are no longer balanced. Instead of a 1:1 ratio, the pool now reflects a 4:1 ratio.
The pool automatically rebalances the assets to equalize their value.
The pool now contains 50 TON and 1000 USDT.
Your share (10%) becomes 5 TON and 100 USDT, worth $200. While your assets have grown, if you had not added them to the pool, you would now have 10 TON (worth $200) and 50 USDT, totaling $250.
This means you lost $50 due to impermanent loss ($250 — $200).
Impermanent loss works similarly if one asset decreases in value. The loss increases more significantly if one asset rises while the other falls. However, if the assets return to their original value, the impermanent loss disappears, hence the term “impermanent.”
You can calculate how much you might lose due to impermanent loss using this calculator.
Pool Metrics
APR: Annual Percentage Return, expressed as a percentage.
APR 24h: Average APR over the past 24 hours.
TVL: Total Value Locked in the pool, expressed in dollars.
Volume 24h: Trading volume in the respective pair over the past 24 hours.
My Liquidity: Your share of the liquidity.
Token Rates: Current exchange rates for the tokens.
Pool Reserve: The quantity of assets in the pool.
APR 7d: Average APR over the past 7 days.
APR 30d: Average APR over the past 30 days.
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