Uniswap, one of the most firmly established Ethereum-based Automated Market Maker (AMM) protocols in the realm, is arguably the most extensive liquidity pool in DeFi. Uniswap enables Liquidity Suppliers (LPs) to earn fees as a reward for contributing their capital to a pool through yield farming. On the platform, liquidity reservoirs are organized between two assets in a 50-50 ratio, a model typical of Automated Market Makers (AMMs).
LPs are of really important for the Protocol’s functionality as a decentralized exchange (DEX), as they provide the liquidity and collateral requisite for the protocol to execute trades in a decentralized manner. In truth, each time someone executes a trade through a liquidity pool, LPs that contributed to that pool earn a fee for facilitating the transaction. The exchange has a trading fee of 0.30% for every token exchange, but, instead of going to Uniswap, these fees are bestowed upon Liquidity Suppliers as a reward for providing capital.
Adding Liquidity On Uniswap v.3
Unlike most DEXes, Uniswap doesn’t contain order books, and its liquidity is sustained through liquidity reservoirs. This indicates that anyone can be a liquidity provider (LP) for a token pair on Uniswap just by depositing equivalent amounts of each token in exchange for token pools. For instance, if a user desired to contribute liquidity to an ETH-DAI pool on Uniswap, they would need to add the exact identical amount of each token.
To contribute liquidity to a Uniswap pool and commence yield farming on the platform, users will need to:
| Visit Uniswap.org.
Click ‘Launch Application’. Choose ‘Reservoir’. Click ‘Connect Wallet’ to connect with Metamask. Once connected, users can either peruse popular liquidity reservoirs by clicking on ‘Top Reservoirs’ or click on ‘Fresh Position’. After having clicked on ‘Fresh Position’, LPs can choose their preferred token pair. They must then pick their favoured Fee Tier. |
It is noteworthy to mention that Uniswap v.3 offers 3 distinct Fee Tiers for every token pair: 0.05%, 0.3%, and 1.0%. The 0.05% Fee Tier is optimal for assets that trade at a fixed or highly correlated rate, such as stablecoins. Thus, this Fee Tier is most fitting for liquidity reservoirs such as DAI-USDC or USDC-USDT, for instance.
The 0.3% Fee Tier is optimal for most pairs, and the ones that undergo price fluctuations, such as ETH-DAI, for example. This elevated Fee Tier is more likely to reimburse LPs for the greater price risk that they undertake relative to stablecoin LPs. The 1.0% Fee Tier is primarily used for exotic pairs, and it is implemented to reward LPs for taking on substantial price risks on their assets.
Determine Price Range
Uniswap v.3 allows LPs to choose a specific price range in which they can provide liquidity, which is one of the perks of the recent Uniswap enhancement. This means that if prices deviate outside the selected range, the user’s position will be concentrated in one of the two assets and will not earn any interest until prices come back into the range. Deposit the desired token amounts and then ‘Add’ and click ‘Preview’ and Approve Transaction on Metamask.
Conclusion
Liquidity reservoirs on Uniswap V3 enable users to provide their assets for exchange and receive a portion of the fees collected from each transaction. This provides substantial liquidity for trading crypto and also creates an opportunity for pool participants to earn money through yield farming. Liquidity reservoirs stand as the centerpiece of Uniswap and have greatly contributed to the DeFi development.
