How to DYOR by analyzing the Liquidity Pool (LP)!
When you invest/trade on DEX (Decentralized Exchange), you may often hear about Liquidity Pool, which is often abbreviated as LP. So... have you ever wondered, what is an LP? then, what is its function? Is there any influence on buying and selling transactions? So, how do you assess projects from LP?
let's review it briefly...!
What is a Liquidity Pool (LP)?
Simply put, a Liquidity Pool (LP) is a supply of crypto assets created in a smart contract by a liquidity provider (Liquidity Provider) which functions as liquidity.
Liquidity Pool (LP) is executed by an Automated Market Marker (AMM) system which means it is an automatic market maker available on Decentralized Exchanges (DEX). In contrast to Centralized Exchange (CEX) where liquidity is provided by the trader himself and executed by the order book.
In a nascent project, the available LPs will become trading pairs. Usually the trading pairs correspond to the network used. For example Babydoge/WBNB or Shib/WETH, and so on. Then…
What is the Influence of Liquidity Pools on Buying and Selling Transactions?
The higher the LP on a project, the faster the transactions in it, the greater the trading volume that can be carried out & the smaller the difference in the price spread. Vice versa, the fewer Liquidity Pools there are, the slower the transactions, the smaller the trading volume and the greater the difference in the price spread. A small LP or even 0 will result in a high slippage difference. This can result in fatal losses for traders and investors. Keep going….
How do you assess a project from LP?
From the explanation above, we can conclude that a large number of LPs can certainly give us more confidence in investing and trading. Apart from that, a lot of LP can provide bigger profits and a longer LP lock can at least minimize the risk of Rugpull. But even so, a large number of LPs and long-term locking cannot be a guarantee for determining whether a project is safe or not.
Thank you for reading, please leave a comment if you have anything to discuss.