The Ecosystem

Decentralized Finance (DeFi) is ruled by two major players conceptually speaking: Traders & Liquidity Providers. Traders buy and sell coins based on opportunity while Liquidity Providers maintain the financial infrastructure by securing liquidity on different platforms where trading takes place.Liquidity as a Service, or LaaS, embraces all activities related to this market where anyone can benefit from both: Being a trader as well as being a liquidity provider to different services. Investors get rewarded as liquidity providers for a wide range of services including liquidity pools for swap based decentralized exchanges, lending protocols, staking platforms and much more. This guide will help you understand all of these options!

Liquidity Pools

Liquidity pools are essential to the DeFi system since they allow traders to operate in the decentralized market. By becoming a liquidity provider on platforms such as Uniswap, PancakeSwap, Sushi, Jupiter, etc. you’re essentially moving the gears that make this engine work.

Decentralized Exchanges (DEX’es) typically work by providing asset pairs for people to trade. Example: A ETH-USDT pair allows traders to buy or sell ETH in exchange for USDT using an Automated Market Maker (AMM) which means people can efficiently trade coins without the need for human intermediaries which makes the process not only faster but morepractical since the transactions are executed by smart contracts at any time.

Yield Farming

Yield farming, also known as liquidity mining, is a process in the DeFi ecosystem where users lend or stake their cryptocurrency assets in order to earn rewards, typically in the form of additional cryptocurrency tokens.
For example you can provide ETH and USDT on PancakeSwap to earn fees plus the CAKE token as incentive on their platform. Investors can either keep such tokens in their wallets or trade them for something else.
‍

When incentives are payed to liquidity providers using coins not emitted or somehow minted by the trading platform itself investors call it “real yield” and it’s preferable because it reduces the risk of such coins losing value through token inflation especially when such tokens are not fully backed by the DEX’es reserves.
Some platforms, such as TraderJoe and Beefy Finance automatically compound any earnings coming from your liquidity pools back into the pools themselves which is a great strategy for fast growing during the bull market but risky in case both coins are not of equal interest to you.

Lending Protocols

Investors can also provide liquidity to the market by lending their assets to the Lending & Borrowing platforms. Lenders profit from lending their coins for a fee to automated platforms such as Aave, Compound, SoLend, etc.

‍
Lent assets can also be used as collateral enabling users to borrow different coins available on such platforms by paying interest which is shared by the platform and by the liquidity providers. Another important aspect of lending/borrowing platforms every investor needs to be aware of is the liquidation system. Liquidation is what happens when an investor borrows a certain amount of coins but the collateral provided is not enough to cover the increase in price for example.
‍

The process of liquidation uses your coins provided as collateral to repay your debt to the platform allowing the borrower to keep the borrowed coins for a price usually called the penalty. Despite its unusual name the penalties are actually used as incentive for other participants called the liquidators, who provide liquidity to repay other people’s debts in exchange for a fee.
The liquidators help prevent protocols from getting their reserves depleted of specific coins besides keeping the DEX liquid enough so lenders can withdraw their assets when they want to.

Staking Protocols

Another very popular method of providing liquidity to the crypto ecosystem is by staking your tokens.
The Ethereum network for example has adopted the Proof of Stake (PoS) method to validate
transactions with the consensus system.

‍
Such validators operate as network nodes usually financed by large investors or groups and they
validate operations by taking the risk of staking their ETH tokens and getting rewarded by fees
generated by such transactions as incentive to keep the system operational.
If a validator fails to keep the network safe for some reason (including unplanned down time) a process
known as slashing liquidates the staked coins as penalty to the responsible validators which then
redistribute the funds to the network.
‍

On the Solana network for example, the SOL token can be staked but it’s more accessible to retail users
because they have adopted a delegation system where small investors can delegate their staked coins
directly to specific validators, besides charging smaller fee for the transactions.

‍
Last but not least we need to talk about Liquid Staking which is a way for investors to delegate their
tokens to be used for staking but also getting a new token in exchange. Such tokens are known as yield-
bearing tokens and their value increases relative to the original token provided.

Example: You can deposit your ETH on the Lido platform and get an equivalent amount of a token
called stETH (staked ETH). This token can later be exchanged back for your original ETH tokens plus some interest

You can keep the liquid stake token in your wallet as a kind of receipt or re-use them on lending
platforms to borrow other assets against it and expand your strategy.

Conclusion

Liquidity as a Service is a very interesting topic given its incredible flexibility that allows investors to
operate in a large variety of ways in the cryptocurrency market. The financial tools available to you in
the crypto space such as liquidity pools, lending protocols, liquidity mining, liquid staking, etc. are not
only powerful by themselves but can also be combined in synergetic strategies only limited by the risk-
reward deal investors are willing take.

‍