Introduction

Liquidity pools are essential components that power decentralized finance (DeFi). Without them, many parts of DeFi wouldn’t function smoothly. Understanding how these pools operate is crucial for navigating the crypto markets.

In this article, we’ll explain the basics of liquidity provision for new users, explore why you might want to become a Liquidity Provider (LP) with FIVA, and show you how to get started.

The Role of Liquidity Pools in DeFi

Liquidity pools are fundamental to DeFi, enabling features like token swaps, lending, and yield generation.

If you’re new to this, think of a liquidity pool as a shared pool of money (tokens) that people contribute to. This pool is locked in a smart contract (a program running on the blockchain). When someone wants to trade one token for another, they interact with the pool instead of waiting for a buyer or seller, as in traditional finance.

In conventional markets, trades only happen when a buyer and a seller meet simultaneously. In DeFi, liquidity pools replace this system by facilitating trades 24/7 without requiring direct matches between buyers and sellers. The tokens in the pool ensure there’s always enough liquidity for smooth transactions.

How Do Liquidity Pools Work?

Let’s break down the concept of liquidity pools with a simple example:

Imagine you hold both TON and USDT. Instead of keeping them idle in your wallet, you could deposit both tokens into a TON/USDT liquidity pool. Now, if someone wants to trade their TON for USDT (or the other way around), they don’t need to find a matching trader. The pool completes the transaction instantly using its token reserves.

Contributors to these pools are called Liquidity Providers (LPs). By adding their tokens to the pool, LPs ensure there’s enough liquidity available for trades, helping DeFi systems operate efficiently.

Why Become a Liquidity Provider?

As an LP, you earn rewards. For instance, in the TON/USDT pool, each time someone trades within the pool, they pay a small fee. A share of this fee is distributed to LPs as a reward for providing liquidity. Over time, your contribution grows in value as these fees accumulate.

It’s like generating passive income — your tokens work for you while you earn rewards. Besides trading fees, some DeFi protocols offer extra incentives, such as native tokens, airdrops, or additional rewards to attract LPs.

This makes liquidity pools an attractive opportunity for those looking to generate passive income or maximize their crypto holdings.

Automated Market Makers (AMMs)

Liquidity pools are the foundation of Automated Market Makers (AMMs). AMMs are smart contracts that use mathematical formulas to determine token prices within the pool. Instead of relying on traditional order books (where buyers and sellers set prices), AMMs automatically adjust prices based on the ratio of tokens in the pool. This ensures seamless, continuous trading without needing intermediaries or centralized parties.

You’ll learn more about FIVA’s unique AMM model in the upcoming article.

Why Are Liquidity Pools Important?

Liquidity pools are crucial for DeFi because they:

• Enable 24/7 trading: Liquidity is always available, so trades happen instantly.

• Eliminate intermediaries: Trades occur directly between users and the pool, bypassing traditional middlemen.

• Provide passive income opportunities: LPs earn fees and rewards by contributing tokens.

• Support decentralized trading: Liquidity pools power decentralized exchanges (DEXs), which are central to DeFi’s open and permissionless nature.

Understanding Liquidity Pool Risks

While liquidity pools offer great rewards, they also come with risks every LP should be aware of:

1. Impermanent Loss (IL)

   Impermanent loss occurs when one asset in the pool changes significantly in value compared to the other. For instance, if the price of TON rises sharply, the pool will rebalance by holding more USDT and fewer TON. In this case, you might end up with less TON than if you had kept it outside the pool. This “loss” is impermanent if prices return to their original levels, but it becomes permanent if you withdraw liquidity while prices remain skewed.

2. Smart Contract Vulnerabilities

   DeFi protocols rely on smart contracts — self-executing code on the blockchain. However, bugs or security flaws can expose these contracts to hacks. For example, the Harvest Finance hack resulted in over $30 million in losses. This highlights the importance of using well-audited protocols with experienced development teams.

3. Oracle and Price Feed Issues

   DeFi protocols often depend on oracles to provide real-time price data. An oracle connects blockchains to off-chain data sources. If the oracle is compromised or malfunctions, incorrect data could be sent to the pool, leading to pricing errors and potential losses for LPs.

4. Governance Risks

   Some DeFi protocols allow users to vote on system changes, such as pool parameters. While this encourages community involvement, it also introduces risks. Large token holders could manipulate votes to favor their interests, potentially harming smaller LPs.

Why Provide Liquidity on FIVA?

Now that you’re familiar with the risks, let’s explore the advantages of providing liquidity on FIVA:

1. No Impermanent Loss

   FIVA’s unique system eliminates this risk through the use of Principal Tokens (PT) and Yield Tokens (YT). For a refresher, go here.

   In FIVA’s pools, the total value is always the sum of PT and YT:

   PT + YT = Underlying Asset Value

   As the pool reaches maturity, the value of PT gradually converges with the value of the underlying asset. Meanwhile, the value of YT decreases as the yield it represents is continuously claimed by YT holders. By the end of the pool's term, YT has distributed all its yield, making its value zero, while PT becomes equal to the underlying asset’s value (e.g., 1 PT = 1 TON).

   This design ensures that, unlike traditional liquidity pools, the value of your position stays intact at maturity — avoiding the usual impermanent loss caused by price fluctuations.

2. Multiple Streams of Rewards

   With FIVA, you earn more than just trading fees. If you provide liquidity using stTON from Bemo, you’ll continue earning staking rewards from Bemo alongside your FIVA earnings. Additionally, FIVA will offer points, governance rights, and other incentives through its rewards program, maximizing your yield.

3. Robust Security Measures

   FIVA prioritizes security. Our development team follows best practices in the TON ecosystem, conducting thorough testnet deployments and collaborating with the community to identify bugs. We are in talks with several auditors to review our smart contracts and ensure the security of your funds. For oracles, we plan to work with Redstone for reliable price feeds, using proven solutions adopted by other major DeFi protocols.

4. No Governance Risks

   Currently, FIVA operates without governance mechanisms, meaning you don’t have to worry about governance decisions affecting your liquidity positions. Your earnings remain unaffected by unexpected protocol changes.

How to Provide Liquidity on FIVA

It’s easy to get started with FIVA. Follow these steps to become a liquidity provider:

1) Go to the Pools section in the application.

2) Choose the pool you want to provide liquidity to.

3) Select the amount of SY and PT tokens you want to contribute.

4) Approve and send the tokens to the pool. Once the second token is sent, you’ll receive LP tokens representing your position.

After that, you can view your current position on the dashboard. In the coming months, we’ll be adding Zap in/out functionalities and a P/L (Profit/Loss) tracker to enhance your user experience.

How to Get SY and PT Tokens

To provide liquidity, you’ll need both SY and PT tokens. Here’s how to get them:

For SY Tokens:

1) Go to the Wrap/Unwrap section in the application.

2) Choose the asset you want to wrap and the amount.

3) Approve the transaction.

For PT Tokens:

You have two options: Mint or Swap.

Option 1: Swap for PT Tokens

1) Go to the Market section and select a pool.

2) Choose the amount of SY tokens you want to swap for PT tokens and approve the transaction. This option allows for easy conversion of SY tokens into PT tokens.

Option 2: Mint PT Tokens

1) Open the Mint tab and select the amount of SY tokens you want to mint into PT tokens.

2) Approve the transaction to receive your PT tokens. You’ll also mint YT (Yield Tokens) representing the yield portion.

YT tokens give you exposure to the yield generated by the asset, which you can hold for future returns or sell in the market for immediate value. This means that not all your capital goes into PT — you also gain yield exposure!

Mint vs. Swap: Which Option to Choose?

• Swapping is typically better if there’s no major slippage.

• Minting is the preferred option if slippage is high or if you want exposure to YT tokens, as minting avoids trading fees.

Looking Ahead

Stay tuned for upcoming articles, where we’ll dive deeper into FIVA’s AMM model, explore new features, and discuss advanced strategies for liquidity providers.

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