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In DeFi (Decentralized Finance) crypto, you can make money by providing liquidity to a liquidity pool. Here's how it works:
When you provide liquidity to a liquidity pool, you deposit two different cryptocurrencies or tokens into the pool. In return, you receive a new token that represents your share of the pool. For example, if you deposit 1 ETH and 100 DAI into a liquidity pool, you might receive 100 LP (Liquidity Provider) tokens that represent your share of the pool.
Whenever someone trades on the platform, the smart contract charges a trading fee, which is typically around 0.3% of the trade value. These trading fees are distributed to all the liquidity providers in the pool based on their share of the pool.
So, if you hold 10% of the LP tokens in a pool, you would earn 10% of the trading fees generated by the pool. The amount of fees you earn depends on the trading volume on the platform and the size of the liquidity pool.
In addition to trading fees, you may also earn rewards in the form of a new token that is used to incentivize liquidity providers to deposit funds into the pool. For example, some platforms offer a governance token that can be used to vote on platform upgrades or changes. By providing liquidity to the pool, you can earn a share of the governance token rewards.
Providing liquidity to a liquidity pool can be a lucrative way to earn passive income in the DeFi space. However, it's important to note that liquidity provision also carries risks, such as impermanent loss and smart contract bugs. So, it's important to do your own research and understand the risks before investing in a liquidity pool.