Riding the DeFi Wave: Understanding Liquidity Pools and Yield Aggregators
The full article was originally published by Accumulator on Medium. Read the full article here.
Decentralized exchanges and yield aggregators have revolutionized the world of cryptocurrency investing, offering new tools to manage DeFi yield including the automation of compounding liquidity pool yield to earn increased rewards. Understanding how to navigate these platforms and take advantage of the opportunities they present can significantly boost your investment portfolio. This is particularly noteworthy since two major dApps recently launched on ShimmerEVM: ShimmerSea, a decentralized exchange (DEX), and Accumulator, an automated yield compounding platform. In this article, we’ll dive deep into the world of liquidity pools on decentralized exchanges and explore how yield aggregators can help you optimize your returns.
Upon reading this article, you can promptly take action and participate in ShimmerSea’s LUM/SMR or DEEPR/SMR liquidity pools, while also utilizing Accumulator to automatically reinvest your rewards, thereby increasing your passive income even further.
Liquidity pools: a new approach to trading
The financial world heavily relies on liquidity to keep things running smoothly. When funds are readily available, financial systems can operate efficiently. DeFi is no exception to this rule.
In a decentralized exchange, when someone decides to trade token A for token B, they depend on the shared liquidity pool of tokens belonging to the A/B pair, which has been provided by other users or in some cases the decentralized exchange protocol (known as liquidity providers). As they acquire B tokens, the pool ends up with fewer of them, which, in turn, causes the price of B to increase. It’s essentially a straightforward application of supply and demand principles.
In return for providing liquidity, liquidity providers receive a portion of the trading fees generated within the pool. It’s important to understand that liquidity providers take on a certain level of risk since they are exposed to price fluctuations of the assets in the pool known as impermanent loss (the opportunity cost of holding the two tokens separately outside of the liquidity pool). However, this risk can be mitigated by the fees earned from transactions, and an additional reward provided by the DEX called LP farming, and many liquidity providers find this an attractive opportunity to earn passive income on their investments.
ShimmerSea is currently offering a variety of liquidity pools. Join now!
Yield aggregators: maximizing returns and reducing risk
The second DeFi tool we’d like to introduce is the yield aggregator. Yield aggregators are platforms that automatically manage DeFi yield strategies automatically including your liquidity pools. They seek to maximize your returns by automating the compounding of the rewards received back into LP tokens, thereby creating a snowballing effect of growth.
Let’s take a how this works in a simple flow diagram below:
Now here’s a live example with and without using Accumulator, please note this is on the assumption the APY remains consistent over the year:
DEEPR/SMR LP farm:
Without compounding effect: 110% APR
With Accumulator compounding effect: 195% APY
If you are planning on providing long-term liquidity to a token that is supported by Accumulator, you will earn additional yield.