CertiK: How Knowledge Equals Wealth Earns Liquidity Yield

The term liquidity pool is highly featured in various announcements and related developments in the circle, but there are not a few users who know little about it.

Compared with liquidity pools, equity pledge, income farming and liquidity mining have always been the focus of investors’ discussions. After all, they are closely related to everyone’s wallets. …

All three of the above methods can generate rewards by locking or staking cryptocurrencies in the yield pool for cryptocurrency holders.

This goes back to our topic today: income mining pool – liquidity pool, so how to use the liquidity pool to earn income must be the most interesting thing for everyone!


The content of this article is only for information sharing and does not constitute any investment advice. Please identify risks and invest with caution!

However, when it comes to making money, you must know yourself and your enemy to be victorious in every battle.

The sloppy entry of the confused novice Xiaobai is often quickly understood by paying the price of money – knowledge represents wealth.

Liquidity Pool

Let’s first look at how liquidity pools work.

If the liquidity pool is regarded as a small market, this small market is “empty” at first, until the liquidity providers (LP), also known as farmers, deposit an asset into this small market – – This behavior is also known as providing liquidity to the capital pool, and then this small market starts to operate.

After the operation starts, users will wait and see which tokens are deposited in this small market, and if they are interested in these tokens, they will choose to borrow or trade.

Once a transaction occurs, users will pay varying transaction fees similar to handling fees, and this transaction fee will be rewarded to liquidity providers (LPs).

This is equivalent to an investment behavior for liquidity providers, so in theory, the more funds you deposit at the beginning, the greater the return in the later period.

What is the difference between trading on a liquidity pool and trading on an exchange?

Obviously we can place orders directly on the exchange, so why bother to use the liquidity pool?

To truly understand liquidity pools, we need to understand the importance of liquidity itself.

If you think of the liquidity pool as a fish pond, there are different kinds of small fish. The more fish you put in it, the more liquidity there is. And more liquidity can provide more stable prices.

Liquidity, as an important part of DeFi, determines how the price of assets in the pool changes.

When everyone can see the price of all fish, everyone is asking for prices at will, which is relatively unfavorable for both buyers and sellers.

Think about it, if there are only two or three fish in the pool, and you want to buy one of them, and the seller puts forward a price that you do not accept, the transaction may never be completed until someone bids over and over again until you are satisfied. At this time, the price of fish (tokens) may experience a wave of K-line shocks, which adds a lot of uncertainty to the transaction.

The order book model followed by centralized cryptocurrency exchanges, similar to traditional stock exchanges, hides this drawback.

In addition to this, the low fees and non-custodial nature of liquidity pools, which can be created by users themselves, is also an important reason for attracting traders.

Compared with traditional finance, the benefits of using liquidity pools are as follows?

  • Ensuring sufficient liquidity to meet the requirements of DeFi protocols
  • Anyone can provide liquidity to these pools
  • Offers multiple levels of profit potential
  • Earning governance tokens provides voting power to oversee decisions about the pool
  • Users autonomously control their digital assets
  • Use of smart contracts

Does the liquidity pool with so many advantages also have corresponding risks?

Risks of Liquidity Pools

Liquidity pools have played a key role in driving the viability of existing DeFi technology stacks using smart contracts.

Its earliest history can be traced back to Bancor’s innovation of market makers in 2017. After the order book was completely eliminated, an on-chain liquidity pool network was introduced to pair token pools with each other. Now liquidity pools have become many The backbone of head DEXs such as Uniswap.

But being a liquidity provider comes with some unique risks.

Such as “impermanent loss”, or “deviation loss”, which is caused by the divergence of token prices.

Let’s take a look at an arithmetic problem (you can skip it if you’re not interested?

You have a principal of $100, and you buy 1 ABC (worth $50) token and 50 USDT into the pool. At this time, the value of 1 ABC is equivalent to 50 USDT.

At this time, there are 10 ABC and 500 USDT in the entire pool, and your share occupies 10%.

However, the price of ABC tokens has dropped by 50%, 1 ABC = 25 USDT, after the transaction, the pool becomes 15 ABC and 250 USDT, and the asset value you get when you exit the venue is 1.5 ABC +25 USDT = $62.5.

But what if you hold funds that are not in the pool? Your capital should be 1 x 25 + 50 = $75.

Therefore, your impermanent loss amount is 75-62.5 = 13.5 dollars.

Of course, the main reason for losing money is the drop in currency prices, and impermanent losses will only make your losses worse.

Another point is the risk of smart contracts.

Once an asset is added to the liquidity pool, it is completely controlled by smart contracts, so if there is a bug or some kind of bug, it is very difficult to recover these assets.

In addition, it is also necessary to be wary of contract owners or developers changing the rules of the fund pool through permissions, such as controlling the funds in the fund pool.

Especially in small pools with low liquidity, the governance of the liquidity pool is too centralized, and under the authority of developers to decide to control the funds in the pool, the funds will be very dangerous. In addition, there are hacking methods such as flash loan attacks. Therefore, users and liquidity providers should be very careful when choosing capital pools and stay away from small and low-liquidity capital pools.

For example, an attack occurred in April 2021 – the liquidity mining protocol Uranium was attacked, and the attacked smart contract was a modified version of MasterChief (MasterChief is a smart contract used to create a staking pool and return staking rewards to users) .

Among them, there is a logic loophole in the code used to execute the “staking reward”, which allows hackers to obtain more mining rewards than others. Hackers drained the RAD/sRADS pool and exchanged it for $1.3 million worth of BUSD and BNB.

And on February 5, 2021, there was an attack on the DeFi project Yearn.Finance. The total loss of the attack was as high as about 71 million yuan, and the hacker made a profit of about 18 million yuan. Hackers obtained the attack start-up funds through flash loans, and used the code loopholes of the Yearn project to complete the entire attack.

From the above two cases, we can see that smart contract auditing is very important. By checking the source code of the contract line by line, the loopholes in the contract can be discovered and help ensure the security of the smart contract.

The Skynet scanning system developed by CertiK is a dynamic scanning system that uses automatic scanning technology to provide users with real-time protection of on-chain transactions, and identifies and marks various malicious vulnerabilities before they occur. It is also possible to monitor the liquidity of the fund pool to help users avoid risks.

write at the end

Liquidity pools have undoubtedly changed the rules of the game for DeFi, and maybe even the entire financial industry. With the security provided by smart contract auditing, there will be more innovation and a new era of liquidity pools.

It realizes decentralized transactions, lending, and yields. In the future digital currency market, with the continuous advancement of technology, smart contracts may also continue to improve, but remember not to ignore related risks, do DYOR (Do your own research) at any time and use third-party security tools reasonably.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/certik-how-knowledge-equals-wealth-earns-liquidity-yield/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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