Glosarry
1. Liquidity Pool
A liquidity pool is a collection of funds locked in a smart contract used to facilitate trades between assets on an AMM platform. Liquidity providers contribute an equal value of two tokens to create a market for those assets.
2. Liquidity Provider (LP)
A liquidity provider is an individual or entity that deposits assets into a liquidity pool in exchange for LP tokens, which represent their share of the pool. LPs earn trading fees based on the amount of liquidity they provide to the pool.
3. LP Tokens
LP tokens are tokens received by liquidity providers when they contribute liquidity to a pool. These tokens can be redeemed for the underlying assets at any time. LP tokens also track ownership of a portion of the liquidity pool and any fees earned.
4. Slippage
Slippage refers to the difference between the expected price of a trade and the price at which the trade is executed. In AMMs, slippage can occur due to changes in a pool's liquidity between the time a transaction is submitted and when it is executed.
5. Swap Fee
A swap fee is a fee charged for every trade executed on an AMM platform. This fee is typically a small percentage of the trade amount and is distributed to liquidity providers as a reward for providing liquidity.
6. Yield Farming
Yield farming involves liquidity providers moving their funds between different pools and platforms to maximize their returns from trading fees and rewards. It often involves staking LP tokens to earn additional rewards in the form of another cryptocurrency.
7. Impermanent Loss
Impermanent Loss occurs when the price ratio of tokens in a liquidity pool changes after a liquidity provider has deposited them into the pool. This loss is "impermanent" because it can be recovered if the prices return to their original ratio when the LP deposited the tokens. However, if the LP withdraws their funds while the prices are still diverged, the loss becomes permanent. This phenomenon is unique to AMMs due to their constant product formula and can result in LPs having less value than if they had simply held onto their assets outside the pool.
8. Constant Product Formula
The Constant Product Formula is the mathematical formula used by many AMMs to maintain liquidity pool equilibrium and determine asset prices. Typically expressed as , where and represent the quantities of the two different tokens in the liquidity pool, and is a constant value. This formula ensures that the product of the quantities remains constant after a trade, which helps the AMM provide liquidity at any price level.
9. Concentrated Liquidity
Concentrated liquidity allows liquidity providers to allocate their capital within specified price ranges, rather than across the entire price curve. This innovation, popularized by newer AMM models, enables LPs to earn more trading fees with less capital by focusing liquidity where it's most needed, at the cost of increased risk of impermanent loss if prices move outside their chosen range.
10. Price Impact
Price impact refers to the change in asset price caused by a trade. In the context of AMMs, large trades relative to the pool size can significantly move prices, resulting in a higher price for buyers or lower for sellers. Price impact is a critical consideration for traders, as it affects the cost and efficiency of trades.
11. Arbitrage
Arbitrage in AMMs involves taking advantage of price discrepancies between different markets or platforms. Traders can profit by buying an asset at a lower price on one AMM and selling it at a higher price on another, thereby helping to maintain price consistency across the DeFi ecosystem.
12. Flash Swaps
Flash swaps are an innovative feature offered by some AMMs that allow traders to borrow assets from a liquidity pool without collateral, execute arbitrage trades, and return the borrowed amount along with a fee in a single transaction. If the final state of the transaction doesn't satisfy the pool's requirements (e.g., returning the borrowed amount plus fees), the entire transaction is reversed, as if it never happened.
13. Token Pair
A token pair refers to the two different cryptocurrencies that make up a trading pair in a liquidity pool on an AMM. For example, an XRP/USD pool allows users to trade XRPL (XRP) for USD and vice versa. Liquidity providers must supply equal values of both tokens in the pair to participate.
14. Automated Portfolio Management
Automated portfolio management refers to DeFi protocols that automatically rebalance a user's portfolio based on predetermined criteria or strategies. In the context of AMMs, this can involve automatically adjusting a user's liquidity positions across different pools to optimize for returns or minimize risk.
15. Governance Tokens
Governance tokens are distributed to users of an AMM and grant holders the right to participate in decisions regarding the platform's development, such as proposing or voting on changes to protocols, fees, or new features. These tokens are a crucial component of the decentralized governance model that many AMMs and DeFi projects employ.
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