Crypto Incentives – Liquidity Pools
DeFi, General - August 25, 2020
Crypto was meant more for Bitcoin trading and crypto arbitrage. Financial advisors and registered investment advisors (RIAs) need to look at crypto beyond its price.
One of the key financial concepts that the DeFi world is building is liquidity pools. In this video we break down what liquidity pools are and why they are so important for financial advisors and RIAs to understand.
Liquidity pools are financial marketplaces where crypto is stored, liquidity is generated and income is received.
Liquidity refers to the ability of an asset to be converted into cash. The faster it can be converted to cash, the more liquid it is. Naturally, since cash is already cash it is the most liquid asset. Bitcoin, Ethereum, and other cryptocurrencies are not very liquid for two reasons. First, they are not widely used as a medium of exchange. Secondly, their price is very volatile.
In the cryptocurrency world, since cash isn’t used, and cryptos like Bitcoin and Ethereum are volaitle, stablecoins are used. Stablecoins are cryptocurrencies with the price equal to cash, like the US dollar.
In liquidity pools, participants can deposit an illiquid crypto (like Bitcoin) for a liquidy crypto (like a stablecoin). The illiquid crypto is used as collateral, and provides liquidity to the pool, for whatever purpose they want. This purpose can be in the form of lending. The depositer either receives a stablecoin or regular interest payments in the same crypto for their deposit.
Liquidity pools are allowing the cryptocurrency world to build its own loan financing system. This is going to be huge in the future. Financial advisors and RIAs should look into it to better serve their clients.
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