blog.alankrit.net

Tag: trading fees

  • Day 23 — Where Does Crypto Yield Actually Come From?

    Watercolor illustration tracing crypto yield back to borrowers, trading fees, staking, and token rewards

    A dashboard may promise five, twenty, or even one hundred percent annual yield, but the percentage is the last part of the story. The first question should be: who is paying, and what useful activity produces the return?

    In a lending market, yield can come from interest paid by borrowers. In a liquidity pool, it can come from fees paid by traders. Proof-of-stake networks reward validators for helping secure and operate the chain, and some of those rewards can flow to people who delegate or stake assets.

    Protocols also distribute newly created tokens to attract users. These incentives can bootstrap a market, but they are not the same as durable revenue. If everyone earns a token only to sell it, and there is no continuing demand for it, the displayed yield may collapse along with the token price.

    Annual percentage yield often assumes rewards are reinvested and the current rate continues for a full year. Both assumptions can be unrealistic. Rates change with utilisation, trading volume, token emissions, and market prices. A high APY can disappear within hours while the underlying asset falls much faster.

    Yield is compensation for something: lending risk, market-making risk, price volatility, lock-up, validator penalties, smart-contract exposure, or simple token dilution. If the source cannot be explained clearly, the return may be circular—paid mainly from new deposits or newly printed incentives rather than productive demand.

    A useful review separates rewards by source, values them in a stable unit, checks withdrawal conditions, and tests what happens if the reward token drops sharply. It also includes gas, slippage, taxes, and impermanent loss instead of focusing only on the largest number on the screen.

    Many yield protocols can change parameters or direct a treasury through community voting. Tomorrow we will look at the organisation behind that process: the DAO, and how decentralised its decisions really are.

  • Day 20 — Why Would Anyone Put Their Tokens Into a Liquidity Pool?

    Watercolor illustration of liquidity providers adding a pair of tokens to a shared trading pool

    An automated market maker cannot serve traders with an empty pool. The assets are supplied by liquidity providers, often called LPs. They deposit a pair of tokens into a smart contract so other people can swap between them.

    Suppose a pool holds ether and a stablecoin. A provider contributes both assets at the pool’s current value ratio and receives a token or accounting record representing a percentage of the pool. If the provider owns one percent of the pool, that claim grows or shrinks with the pool’s reserves.

    Every swap usually pays a small fee. The fee remains in the pool or is distributed according to the protocol’s design, giving LPs a reason to provide capital. More liquidity also benefits traders by reducing slippage, so a healthy market tries to balance useful depth with a fair return for providers.

    The catch is that the pool constantly rebalances the two assets as prices move. If ether rises sharply, arbitrage traders remove ether from the pool and add stablecoins until the pool matches the outside price. The LP ends up holding less of the asset that rose and more of the asset that lagged.

    Compared with simply holding both tokens, this difference is called impermanent loss. The name can be misleading: if the provider withdraws while prices are far apart, the loss relative to holding becomes real. Trading fees may offset it, but they are not guaranteed to do so.

    LPs also face smart-contract bugs, malicious tokens, oracle or bridge failures in some designs, and the possibility that an incentive token loses value. A high advertised annual return says little unless we know the trading volume, fee income, price risk, and source of extra rewards.

    Liquidity provision turns passive assets into market infrastructure, with rewards tied to real risks. Another kind of pool uses deposits not for swaps but for loans. Tomorrow we will see how lending can work without a bank checking your credit score.