Hey everyone, just rewatched the video and realized I might not have explained how tokens in a liquidity pool are reallocated or rebalanced as clearly as I could have. Basically, when the value of one token goes down, the pool automatically balances itself out. This usually happens because there’s a spike in demand for the other token-more people are swapping one asset for another, which throws off the balance in the pool and changes the ratio of tokens you hold. Diving a bit deeper, this all revolves around something called the constant product formula, represented as k. It’s what keeps the relationship between the two tokens in check. The formula is pretty straightforward: Token1 x Token2 = k. Whenever a trade is made, the quantities of these tokens adjust to make sure this product stays the same. Here’s the practical side of it: when more people want one token and start trading for it, the pool has to shuffle things around to keep k constant. This helps keep the pool stable but can lead to what we call 'impermanent loss.' This type of loss happens when the prices of the tokens when you withdraw them have shifted from when you deposited them. It's super important to grasp this if you're thinking about becoming a liquidity provider because it shows you how you can earn from transaction fees but also the risks from price changes in the pool. Hope this clears things up a bit!
As an example if I put in 1BTC in a pool of BTC/ETH the rewards are always in BTC or eth right? So this is a good way to accumulate appreciating assets as long as you want to hold BTC or eth long term…right?
Hey everyone, just rewatched the video and realized I might not have explained how tokens in a liquidity pool are reallocated or rebalanced as clearly as I could have. Basically, when the value of one token goes down, the pool automatically balances itself out. This usually happens because there’s a spike in demand for the other token-more people are swapping one asset for another, which throws off the balance in the pool and changes the ratio of tokens you hold.
Diving a bit deeper, this all revolves around something called the constant product formula, represented as k. It’s what keeps the relationship between the two tokens in check. The formula is pretty straightforward: Token1 x Token2 = k. Whenever a trade is made, the quantities of these tokens adjust to make sure this product stays the same.
Here’s the practical side of it: when more people want one token and start trading for it, the pool has to shuffle things around to keep k constant. This helps keep the pool stable but can lead to what we call 'impermanent loss.' This type of loss happens when the prices of the tokens when you withdraw them have shifted from when you deposited them.
It's super important to grasp this if you're thinking about becoming a liquidity provider because it shows you how you can earn from transaction fees but also the risks from price changes in the pool. Hope this clears things up a bit!
Thank you for the content! This was helpful
You're welcome!
Please keep going with those videos
Thank you @SkittelsBoy! Will do!
As an example if I put in 1BTC in a pool of BTC/ETH the rewards are always in BTC or eth right? So this is a good way to accumulate appreciating assets as long as you want to hold BTC or eth long term…right?