Liquidity pools

What are liquidity pools?

Explained in clearer terms, when a user supplies an asset – provides liquidity to the pool, it automatically becomes a fungible resource. The token deposited in the liquidity pool is denoted with a value or derivative. This gives the supplier ownership rights of the reward paid on the total amount supplied.

The assigned derivative is thus defined as an increasing percentage ownership claim of a portion of the liquidity pool supplied to the smart contract on the Arbitrum blockchain. With this, supplying liquidity to the pool is equal to having a derivative which represents the supplier's contribution in the liquidity pool.

How it works?

Whenever liquidity is deposited into a pool, special tokens known as liquidity tokens are minted to the provider’s address in proportion to how much liquidity they contributed to the pool. These tokens are a representation of a liquidity provider’s contribution to a pool.

Whenever a trade occurs, the fee which is levied is distributed pro-rata to all LPs in the pool at the moment of the trade. To receive the underlying liquidity back, plus any fees that were accrued while their liquidity was locked, LPs must burn their liquidity tokens.

When a liquidity provider make a deposit of their token into Liquidity Pools, they will receive LP token and a share of the transaction fee.

When you send STACK and Ethereum to the liquidity pool, you will receive STACK - ETH LP tokens, the number of LP tokens you receive will represent your share in STACK - ETH Liquidity Pool. You can get your capital back at any time by removing your liquidity

Reward of Liquidity Providers

Providing liquidity gives you rewards in the form of trading fees when people use your liquidity pool.

For example:

1. There are 50 LP tokens representing 50 STACK and 50 ETH tokens and we have: 5 LP token = 5 STACK + 5 ETH

2. Someone trades 50 STACK for 50 ETH and someone also trades 50 ETH for 50 STACK.

3. STACK/ETH liquidity pool now has 50.085 STACK and 50.085 ETH.

4. Each LP token is now worth 1.00017 STACK + 1.00017 ETH.