Crypto asset owners can earn money by providing liquidity to decentralized exchanges. Which protocol to choose and what are the features of different applications? Decentralized Finance (DeFi) Applications Give Cryptocurrency Owners the Opportunity to Earn Passively. In most cases, users provide liquidity to DeFi protocols: lend crypto assets to other users of the application. Decentralized exchanges (DEXs), and especially automated market makers (AMMs), are the protocols with the highest liquidity needs and the highest transaction flow. The explosive growth of the DeFi industry, with over $63 billion worth of assets already locked in applications, has attracted the attention of cryptocurrency users for a reason.. A couple of years ago, experts expressed doubts about the advisability of the existence of decentralized cryptocurrency exchanges.. However, by the spring of 2021, the largest DEXs – Uniswap, Curve and SushiSwap – entered the TOP 10 DeFi applications.. At the same time, further development of protocols is impossible without a constant influx of users. The more liquidity an exchange has, the better it performs. Therefore, protocols compete with each other for providing attractive offers for liquidity providers no less than for the availability and simplicity of the service for traders. An overview of the largest automated DeFi market makers will be useful for crypto asset owners who are considering becoming a liquidity provider and earning from it. This is not an exhaustive guide, but it will help both beginners and experienced investors navigate the DeFi market and choose the most suitable offer. The choice of platform matters, because in addition to providing their crypto assets to the application, the user becomes part of a community that has the right to vote. Applications work best where users do not neglect their right to vote and actively participate in the development of the protocol. We remind you that each potential investor in the DeFi market should independently study the offers of the industry before investing in a project. How AMMs work The basic principle of how automated market makers work: users do not trade with each other directly, but with the help of a smart contract. AMM is always ready to buy or sell a crypto asset at the price closest to the market. AMM is usually a series of pools of two assets, such as ETH and DAI. The price offered by the market maker is the value of crypto assets in relation to each other. If there were 1 ETH and 2,000 DAI in the pool, 1 DAI would cost 0.0005 ETH and 1 ETH would cost 2,000 DAI. However, if someone bought 0.01 ETH for 20 DAI, the price will change – now DAI will be 0.000495 ETH. A tiny change, but the shift is getting bigger as deal size grows. Each trade changes the base price. A big deal will knock the pool out of the league with other markets, but you can rely on arbitrageurs to get it back up and running. This is not a bug, but a feature of AMM. In addition, automated market makers with enough pairs of crypto assets can trade between any two crypto assets from the listing of the site, even if they are in different pools.. A user can trade BAT for ZRX, for example by selling BAT for ETH and then ETH for ZRX, all in one transaction in a wallet program such as Metamask. This idea was first proposed by the developers of the Bancor protocol.. Once implemented by Uniswap, the concept proved to be a workable business model, and every major automated market maker developed its own iteration.. Understanding how different protocols work can help a potential liquidity provider understand which DEX is best for them. Uniswap Uniswap is one of the market leaders. Protocol liquidity exceeds $5.6B, according to DeFi Pulse, making it the sixth largest application in DeFi. In May 2021, the developers of Uniswap launched the third version of the protocol, which, according to them, will help the application become “the most flexible and efficient automated market maker ever created.” New version of the protocol solves the problem of wasted liquidity. Each deal changes the price in the AMM pool, more precisely, the price changes even within the deal. In most cases, it doesn't matter, but if someone trades a significant amount of tokens in one pool – an amount that has a significant impact on the price of the pool, the final trade price will be the average of a series of prices. For example, there were 1 ETH and 2000 DAI in the pool. If someone wanted to buy 0.5 ETH, the trade would have thrown the price of ETH and DAI sharply out of balance with the larger market. Such a deal would have serious consequences and it is unlikely that anyone would decide to make it.. If no one wants to make trades that use most of the liquidity on one side of any pool, then no one will ever buy all the ETH or DAI in the pool. Only a part of them can be sold – there is a problem of wasted liquidity. Uniswap V3 creates a different system that gives liquidity providers more control over the price ranges in which their capital is used, with limited impact on liquidity fragmentation and gas inefficiencies. Liquidity providers can set minimum and maximum prices for their stake in any given pool. According to the developers, this will lead to an increase in liquidity in the protocol. This enables traders to make much larger trades within the normal expected price range of a crypto asset pair. Stablecoins are the simplest example of why this system will bring positive changes to the application. One USDC should normally trade for 1 DAI because both are pegged to the US dollar at a 1:1 ratio. However, in a simple AMM, a big trade can drastically change the price of both crypto assets. However, in Uniswap version 3.0, a trader will only be able to require their liquidity to participate in trades where DAI is traded for no more than $1.01 and no less than $0.99. If $1 million of liquidity is invested with this parameter, then a trader can be guaranteed a deal worth, for example, $500,000 with price slippage of no more than a cent. For small investors looking for passive income, working with Uniswap can be a daunting task, but the new system will be useful for all traders.. The new version of the protocol may also have an effect on other platforms.. For example, having positions with concentrated liquidity on Uniswap means that the best execution of trades most of the time will occur on Uniswap. The yield of passive liquidity providers in other applications will decline. Some market experts predict the emergence of new services that will accept assets from retail investors and actively manage their listing on Uniswap to make it easier for ordinary people to access the leading decentralized exchange. Other features Customizable pools will result in the ability for some traders to place buy orders at specific prices. For example, a trader can plan in advance to buy assets when the market declines.. Uniswap developers call them “variable pools”. Uniswap version 2.0 introduced fast swaps – the entire pool of tokens can be borrowed for the duration of one Ethereum transaction. In the previous version of the protocol, the developers also introduced an oracle, or an external source of price data, which was improved in version 3.0. Uniswap allows liquidity providers to set up pool fees in version 3 of the protocol so they can, for example, charge higher fees on infrequently traded pairs. Previously, trades in all Uniswap pools had a commission of 0.03%. The Uniswap community was the last major AMM to issue a protocol governance token. When it happened in September 2020, the free distribution of UNI as a reward for participating in the operation of the protocol to each user became one of the most important events in DeFi in 2020.. Uniswap briefly launched a liquidity mining program to further distribute UNI as a bonus to liquidity providers in key pools. The program was then curtailed according to the original plan and was not resumed. Despite the fact that UNI has grown in price significantly, as a governance token, it has not yet had a big impact on the fate of the protocol.. As of May 2021, there were only three proposals on Uniswap that could be voted on by UNI holders. Two of them failed, and one, the creation of a small grant program for the UNI community, was approved on December 26, 2020. Uniswap is a venture capital backed company. It looks like the core team of the protocol plans to keep control of the application for a long time.. A minimum of 4% UNI is required to vote on any management decision for a final decision to take effect.. Failure to reach such a quorum doomed two proposals in 2020 to failure. The desire to maintain control is also reflected in Uniswap's decision to limit commercial or production use of the Uniswap v3 source code for two years, after which the protocol will be distributed under a perpetual GPL license. SushiSwap SushiSwap has a community-influenced AMM reputation. While Uniswap is an automated market maker for insiders, SushiSwap has opened up to a wider range of users and has never stopped distributing SUSHI governance tokens to its liquidity providers. SushiSwap launched late summer 2020 during the DeFi boom. The developers used a clever concept called “vampire mining”, in which the SushiSwap team convinced Uniswap liquidity providers to transfer their crypto assets to the new application and allow the protocol to move all assets to SushiSwap. SushiSwap managed to transfer liquidity from the “parent” platform to its own. As a result, the volume of assets blocked on Uniswap temporarily fell by 75%. However, after SushiSwap stopped extracting liquidity from Uniswap pools, Uniswap actually had more assets under management than when the SushiSwap campaign started. As a result, Uniswap was again at the top, and SushiSwap had a change of leadership, and the protocol fell significantly in the ranking of DeFi applications.. Decrease in SUSHI rewards and then the debut of UNI led to the return of some liquidity providers to the original platform. However, as of May 2020, SushiSwap is still one of the top 10 DeFi applications, with the value of locked assets in the protocol reaching almost $3.3 billion.. Onsen pays additional rewards in SUSHI to those who deposit crypto assets into it. This helps to attract new users and builds loyalty to SushiSwap as some projects enter a new stage of development. While Uniswap focuses on operating as a decentralized exchange, SushiSwap is expanding into other areas of DeFi. Recently, the developers of the protocol launched the Bento Box, a pool of capital that other DeFi applications can connect to.. The first application on Bento was Kashi, a lending protocol that limits risk for collateral providers. The combination of a lending service with a decentralized exchange creates opportunities for long or short positions with leverage, but not only. Market experts suggest that Sushiswap's niche could be the rapid launch of peripheral products based on core applications.. In addition, SushiSwap is also planning to release the third version of the protocol in the near future. In March 2021, Sushiswap developers launched the platform’s smart contracts on five new blockchains at once: Moonbeam Network, Binance Smart Chain, Polygon, Fantom and on the Ethereum sidechain xDai. The project team also plans to launch an application of Ethereum second layer solutions, such as Optimism. Extra Income Uniswap and SushiSwap charge the same trading fees, but SushiSwap has never stopped its liquidity mining program. Liquidity providers who place their crypto assets in Sushi Bar SushiSwap continuously earn SUSHI. The SUSHI community stimulates significant activity in the field of protocol management. The SushiSwap community is considering quite a few proposals, which can be seen on the voting page. BentoBox is a good example: this idea came from a community member. Once the offer was approved, he designed it and now earns a small fraction of the app's commissions. Curve Finance Curve is a protocol ahead of Uniswap in dealing with stablecoins. Long-time No. 2 Curve Finance surpassed Uniswap in the value of locked crypto assets in May 2021 to become the largest automated market maker in the DeFi industry. Curve Finance has developed a new AMM formula specifically for pools with pairs of tokens, the price of which must change in sync with each other. The price of stablecoins USDC and DAI, as well as USDT and TUSD, should be pegged to the US dollar in a ratio of 1:1 with small deviations. Similarly, WBTC and renBTC prices should move pretty much in sync because both are wrapped BTC.. Curve was designed so that the price curve starts to shift at the far outer edges of the liquidity bands. One of the key design differences between Curve and Uniswap or SushiSwap is that the protocol handles multi-token pools more easily.. This made Curve useful for the Yearn Finance DeFi protocol because it had strategies to allow users to earn income from all major stablecoins: DAI, USDC, USDT and TUSD. Tokens called, for example, yDAI and yUSDC became confirmation of the deposit in these strategies. Curve created a dedicated pool to make it easier to switch between these four pools.. In addition, users who intend to HODL a specific Yearn token can still deposit Curve liquidity and receive transaction fees. Curve has carved a niche in trading crypto assets that are not volatile relative to each other. “We have pools for volatile pairs that are in the last stages of the audit,” says protocol creator Mikhail Egorov. This means that Curve is ready to face other AMMs directly. One of the main ideas of the Curve team is to implement the concept of metapools – running pools for pools. Protocol developers also plan to expand beyond Ethereum. In February 2021, the application team announced plans to launch a platform on the Polkadot blockchain. Governance Token Similar to SushiSwap, Curve users can increase profitability by earning a CRV Protocol Governance Token – Curve launched a liquidity mining program in August 2020. Liquidity providers in Curve pools can earn CRV, however the protocol distributes more tokens to users who have been supplying liquidity for longer. Such a system can only be beneficial when supplying large volumes of liquidity. Community The main management activity for CRV holders is deciding how much CRV liquidity providers earn for different pools. This is one of the ways to attract new liquidity to the platform. For example, when USDT became popular on Ethereum, the pool returns were extremely high early on as the protocol tried to fill the pool.. However, as it was filled and distributed by CRV, the yield became more reasonable. Curve protocol management system is complex. For example, voting does not take place with the help of CRVs themselves – as a result of the supply of liquidity, veCRV accumulates in users' accounts, which has no value, except that it can be used for voting. Bancor Bancor was the pioneer of the basic AMM model, but throughout 2020, when the value of locked assets in other applications reached several billion, the protocol was stuck at several million. However, this changed at the end of the year, and as of May 2021, Bancor is one of the top five decentralized exchanges with over $1.5 billion worth of locked crypto assets. The protocol offers advantages for liquidity providers, such as one-way liquidity, which is unique to the sector.. Most automated market makers require the user to provide two crypto assets equal in dollar value. Some AMMs automate the exchange of half of the deposit for another crypto asset, but the user pays a transaction fee, which in the spring of 2021 in Ethereum reached $70. Bancor issues the required amount of its own BNT token instead of an exchange. When AMM pairs each asset with its own token, it facilitates transfers between any two crypto assets in the service listing. If a user wants to exchange WBTC for BAT, Bancor can simply exchange WBTC for BNT and then BNT for BAT. To the user, this looks like one transaction. The protocol can issue BNT as needed to create the other half of any deposit in the pool. The Bancor team calls it joint investment with liquidity providers. Basically, all BNT holders pay a small amount as the supply increases for each new liquidity provider. But it's likely paying off as the rise in liquidity providers improves Bancor's performance, which means more demand for BNT.. This should have a positive effect on the price of the token in the long run.. The most obvious problem is the impact of the issue on the price of BNT for its holders in the short term.. Bancor also has a program to create deflationary pressure on the token by burning some of the fees. Unique Characteristics In addition to one-way liquidity, Bancor's uniqueness lies in solving the problem of floating loss or intermittent loss. If the value of one crypto asset in the pool decreases relative to another, the value of the liquidity provider’s deposit may decrease in fiat terms, even if the total deposit in underlying crypto assets increases. Floating loss is one of the main problems for AMM. To reduce the impact of this problem on the protocol, Bancor has developed an insurance contract. Users who receive a floating loss on Bancor are guaranteed to retain the full amount of liquidity in terms of the value of their initial deposit if they remain in the pool for at least 100 days. A similar model was implemented by the Thorchain protocol, which will be discussed later. Bancor also launched limit orders. This is a common feature on centralized exchanges, but not in many AMMs, mainly because traders experienced enough to apply limit orders use trading aggregators like Matcha and 1inch to achieve the same result. Bancor is a multi-chain project. The BancorX decentralized application allows you to switch between the EOS and Ethereum networks. Liquidity providers who put earned fees back into pools may earn increased rewards over time. This encourages liquidity providers to stay longer in the pool. The Bancor community is managed through the Bancor DAO. Voting takes place among the holders of the vBNT Protocol Governance Token, a derivative of the BNT token that can be earned by supplying liquidity. The latest version of the governance model was launched at the end of March 2021. Thorchain Thorchain is one of the two AMMs in this review that does not work on Ethereum. There is little AMM activity outside of Ethereum. The outlook for Thorchain is still unclear as it is a relatively new protocol launched in April 2021. Thorchain uses a completely different settlement approach than any of the above protocols running on Ethereum – it trades directly between blockchains. Thorchain is based on the Tendermint consensus algorithm, just like the Cosmos blockchain. Thorchain uses mechanics very similar to those pioneered by Bancor. Other protocols exchange crypto assets within the blockchain they operate on.. Some can transact across blockchains, but use workarounds to do so. Thorchain has its own blockchain, originally designed to operate on multiple architectures. Like Bancor, it uses its own RUNE token to make transactions between BTC and ETH, for example.. However, unlike Bancor, it does not offer users a “wrapped” (synthetic) version of the crypto asset.. A trader can deposit BTC into Thorchain from their wallet and receive ETH to their Ethereum wallet. Like Bancor, Thorchain offers a floating loss protection guarantee for deposits made for at least 100 days.. During the launch, the protocol team noted that temporary losses rarely occur when liquidity providers remain in the pool for such a long time.. However, this does not guarantee complete protection against floating losses. The RUNE governance token is a governance token as well as an instrumental network token. Users earn newly issued RUNEs for acting as liquidity providers. The amount of RUNE that goes into each pool depends on how much income was generated from that pool in that block. The most recent RUNE goes to the most active pools. Community The team behind the creation of Thorchain decided to remain anonymous and avoid the spotlight as much as possible. The developers have set a goal in the summer of 2022 to transfer control of the project to RUNE holders. PancakeSwap As of May 2021, in the Coingecko decentralized exchange rankings, PancakeSwap ranks first with a daily trading volume of $7.84 billion, while Uniswap is in second place with $3.7 billion. According to Defistation, the value of crypto assets locked in the protocol exceeds $9.8 billion. PancakeSwap is a Uniswap fork built on Binance Smart Chain (BSC). BSC is powered by a Proof of Staked Authority (PoSA) consensus mechanism, with 21 active validators selected daily by Binance Chain, a network run by just 11 validators. BSC validators block for BNB staking. However, some analysts have raised concerns about the centralization of validators, which are controlled by the Binance exchange.. This model makes BSC faster and cheaper to use, but significantly more vulnerable to hacking. BSC is compatible with Ethereum smart contract logic, making it easy to fork successful Ethereum projects on BSC. PancakeSwap is an example of that. However, in mid-April 2021, the protocol ran into problems, which led to a temporary stop to its work. Additional income As with other AMMs, PancakeSwap's liquidity providers earn commissions from trades within the pools they participate in. Since trading volumes on PancakeSwap are very high and transaction fees are much lower than on Ethereum, activity in the protocol should increase, allowing participants to earn more profits.. Liquidity providers also receive a CAKE protocol control token. Community The PancakeSwap community is quite active in managing the protocol.. In general, participants approve an increase in CAKE rewards for new pools to get early liquidity and increase user interest, similar to the SushiSwap Onsen program. CAKE holders also decide how to change the transaction fee and how to distribute it. Notes Bits.media staff reminds that crypto asset owners should make their own decisions about participating in DeFi automated market makers as liquidity providers. DeFi applications allow you to earn additional income, but their operation comes with risks that you need to be aware of before putting your cryptoassets into the protocol pool. Any protocol can be hacked, prone to errors, vulnerabilities and unfair behavior on the part of the project team. The above information is current as of mid-May 2021. The market can change quickly and you need to study each DeFi application yourself before you start working with it.