Liquidity Pools Simply Explained (2024)

By Susan Njuguna

Liquidity pools are collections of funds that are locked in an exchange to facilitate trading of tokens without third parties. They allow you to provide liquidity and earn fees from the trades that occur in the pool. To provide liquidity you need two tokens that will be exchanged for one another in the pool.

Apple and Mangoes Analogy

While creating liquidity, you set the range of the price you want to provide liquidity for. To illustrate how liquidity pools work, let’s use an analogy of Apples and Mangoes. Imagine you have a market where you can exchange Apples for Mangoes. As a trader you need both fruits. For people to trade in this market they must have one of the fruits. If they bring mangos to the market, they get Apples. If they bring Apples, they get mangos.

In this market the price of mangos is well known from other markets but since Apples are a new fruit that has been introduce in this market, its price is determined by the price of the mango. Now, if the price of the mangoes goes up the price of the Apples also goes up. However, as a trader you determine what price you want to exchange your fruits for, and this is where setting a range comes in. You can decide the price range at which you are willing to sell your Apples. For instance, you can say that you will only sell your Apples when one apple is worth between $1 and $2. If the price goes above or below this range, you will not participate in the market.

Actuate and BNB

In this case the Mangos represents BNB which has been in the market for long, and Actuate is the Apples that have just been introduced to the market. The price of Actuate is determined by the price of BNB. However, you set the price range that you are willing to sell or buy Actuate.

Setting the Range

The range you set determines how much liquidity you provide at different prices, and how much trading fees you earn. Thus, concentrated liquidity earns you more than full range. The higher the range the lower the fees you earn and the lower the range the more the fee. We encourage you to choose a narrower price range for your pool, which means you only provide liquidity within a certain price band. This way, you reduce the exposure to price fluctuations and earn more fees from concentrated liquidity. With a narrow price range sometimes, the price may move out of your range. This means your liquidity pool becomes inactive. and you will not earn any fees until the price returns to your range. To counter this you can create multiple positions with different ranges and capture more opportunities.

How do you earn from creating liquidity pools?

The fees are collected from the traders who use your pool and are proportional to your pool share and the fee tier. The rewards are distributed by Actuate and BNB to incentivize liquidity provision and are based on various factors, such as pool volume, pool ratio, pool age, and governance votes. To maximize your fees and rewards, you can monitor the market conditions and the pool performance and adjust your pool parameters accordingly. You can also claim your fees and rewards regularly and reinvest them into your pool to increase your pool share and compound your returns.

Pro tip and Trick.

One of the secrets to building wealth is to harness the power of compound interest. You don’t need a lot of money to start; you can begin with what you have and increase your investment gradually. For example, you can add 1 Actuate per month to your liquidity pool and see your pool value grow over time. 1 Actuate is equivalent to one dollar, so you will be investing only two dollars per month. As Warren Buffett, one of the richest people in the world, said: "The money you make is a symbol of the value you create." If you want to create value and wealth, you have to invest consistently and wisely. Don’t wait any longer; start now.

Here are steps to create liquidity pool and to set the range

To set the range for your liquidity position, you need to follow these steps: