With the rise in decentralized finance or the DeFi market, the role played by liquidity providers has also started to expand. Liquidity providers basically gather or pour crypto funds into a pool for other traders to conduct smooth swaps on the platform. This is conducted with the help of smart contracts. The providers are also able to generate passive income on the basis of the fees charged to the users using the pool.
Liquidity pools allow traders to trade crypto assets on decentralized exchanges. The liquidity providers are the first to make a stake with their own crypto assets. This stake is then set at an equal rate between two exchanging tokens to ensure that there is no arbitrage. The rewards received by the liquidity providers increase as the stakeholders start to invest in the pool. The higher the number of stakeholders involved in the pool, the greater its strength creating a positive feedback loop for the providers as well as the users.
A price adjustment takes place after every successful crypto exchange. This is conducted with the help of automated market makers or AMMs. Different exchanges have different liquidity pools as well as providers. Incentives to stakeholders are given by the providers using various AMMs to adjust the value. A few examples of AMMs are Uniswap, PancakeSwap, Curve, etc.