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How Do Decentralized (DeFi) Platforms Work?

defi

& how can you make money on them?

Hola to everyone!

Today we’re gonna be explaining the work of decentralized platforms (DeFi), the structure of liquidity pools, and how to work with them.

In general, if you have previously used or will be using Pancakeswap, Sushiswap, Uniswap, etc. this article will be very interesting and useful for you.

First, let’s find out what you can do on such platforms

Let’s take a platform like PancakeSwap as an example. 

In fact, there are many more such services, and in some cases, these are original platforms, and in some, they are some kind of “aggregators” so-called.

All decentralized platforms have few basic features.

First of all, they all can work simply as a regular coin exchange platform

A standard user comes in and exchanges his assets for some others. As a rule, on such platforms, those coins are listed are not yet listed on centralized platforms, such as Binance, for example. This is good, since using DeFi exchanges may be the only possible way for you to buy new tokens on the market. 

Every time users make an exchange, they turn to those so-called “liquidity pools”.

Imagine a store where goods are exchanged not with some kind of universal medium of exchange (like fiat money), but with the help of other goods.

In such a “store” there can be several owners who have different types of “goods” in stock. Using this analogy, those users who sent their coins (liquid pairs) to such a “store” are called “liquidity providers” and you can also drop your coins into the corresponding pool by creating such a pair.

Accordingly, platforms like “Pancakeswap” are organizations that collect a large number of such “pools”. Each side has its own benefit here.

What do users get by providing their coins to the pool?

They receive a commission from the platform for any transaction made on your liquid pair. For example, if a supplier has contributed about 10 percent of the total (and the total is 100 $), then his commission will be 10 $.

Farming

This is where the main reward for providers lies. 

Pharming is arranged for those pools with which various partnership agreements are made from the organizer (in this case, Pancakeswap acts as the organizer) and the administrator of a particular token. 

Accordingly, the central core of this entire mutually beneficial exchange system is… (guess what?) the pool.

Each pool has 3 indicators, which, in fact, determine its work:

  • Trading volumes. The higher the trading volume –  the higher the commission for liquidity providers and platform organizers is. Also, the larger the trading volume in the pool, the closer the coin price is to the average market price. You may have noticed that on different exchanges the rate of a particular coin can vary (up to 5 -20%, or even more). In such situations, “arbitrageurs” enter the scene. These guys buy an asset on one exchange and sell it on another, “averaging” the rate and eliminating the difference, making the rate on all similar sites approximately the same.
  • Liquidity. The entire amount of funds (coins) that are blocked for transactions in the pool from all liquidity providers. The volume of liquidity is important and directly affects its volatility (how much the price of a particular liquid pair changes during a transaction). It is important for organizers that the price does not jump too much, and in consequence, they are interested in high liquidity in the pool (this ensures low volatility).
  • Security. Previously, some danger for novice investors was represented by such a phenomenon as “exit-scam”. The organizers of the new coin begin to actively promote their coin, users pump up the coin with their funds, buying up shares and significantly raising both the price of the coin and the total volume of said pool. 

Further, the organizers withdraw all the liquidity from the pool and disappear, and the coin, in fact, simply dies in your wallet, leaving you with a huge amount of useless tokens that cannot be sold.

DeFi platform regulates this moment, by blocking all the liquidity in the pool, including for the organizers themselves, making it impossible to withdraw it in the early stages. 

That’s all for today, folks.

We do not want your head to shrink to the size of the Dogemoon token at the current rate (the author’s personal pain) due to the excess of new information, so in the next article, we’re gonna dive deep into the insights on how the liquidity pool works in practice.

Till then… 

Adios!

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  1. Mr Bobby

    Thx for useful article )

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