To determine a single-sided liquidity pool, you first need to know what a liquidity pool is all about. It is a collection of funds you lock into a smart contract using a DeFi platform. On the platform, anyone can deposit assets and receive rewards for providing liquidity to a platform.
Hence, you can provide liquidity to a platform like Uniswap by depositing your funds into that liquidity pool. So, you are the Liquidity Provider. Furthermore, you can use that platform to invest in crypto tokens, and in exchange, you are charged a fee.
The trading fee is then distributed to the Liquidity Providers, rewarding them for providing liquidity to the platform. Hence, for a DeFi platform, liquidity is essential. But what does a single-sided liquidity pool do with all of this?
Single Sided Liquidity Pools
Single-sided liquidity pools solve two major problems for a liquidity provider (LP). First, an LP is exposed to a price movement when having multiple tokens and can lose the extended position when having favorite tokens.
The second problem you can face is value loss which happens when those prices diverge and cause underperformance; that is, buying and holding on to tokens. So, you get a single-sided liquidity platform protection powered by a specific platform.
Thus, you can provide liquidity using only one token with full exposure to that token and maintain it. Hence, you can stay longer on your single asset instead of exposing yourself to multiple purchases. You can collect more returns while you earn your swap fees and the mining rewards.
The swap fees are automatically compounded in that pool and are rewarded in staked tokens. You can then re-take the rewards manually into the protocol using a single-sided manner to compound the yield. So, in short, this is how it will work:
- You invest liquidity to the pool through a risk asset like ETH, LINK, WBTC, etc.
- Hence to support the single-sided non-deposits, the entity co-invests them in its pool to match the user deposits. So, for instance, you deposit $100k in ETH, which triggers a $100K token emission by the entity back into the ETH pool.
- Thus the entity investment remains in that pool earning fees until the user-deposited ETH withdraws, and at that point, it burns the amount invested and the accumulated costs.
- The protocol invested token can also burn if the token holder provides a token to the pool. Thus the user-deposited tokens take over that protocol position in that pool and burn an equal value of the protocol invested.
Still, throughout the scenario, you get added impermanent loss protection. The reason is that it removes the IL that occurs when prices of tokens diverge in different directions. The platform does this using the fees earned from the co-investments in the pool to compensate for the wide costs of IL.
Final Thoughts
As you can see, investing money into a single-sided liquidity pool is one of the best solutions not to lose a long positioning of your favorite tokens and still make money while at it.
