The Complete Guide to NFT Liquidity Pools
This might not be news to you, but NFT liquidity pools are gaining traction as a new way to trade non-fungible tokens (NFTs). Unlike traditional markets, NFT liquidity pools provide a decentralized and automated way for buyers and sellers to exchange tokens without the need for intermediaries. This means achieving the much-desired liquidity in the NFT market.
This article will explore how AMM NFTs work, and compare NFT AMMs with NFT marketplaces. Furthermore, it will discuss the different types of NFT liquidity pools, and review some of the best AMM NFT platforms available today. So, if you don’t want to stay behind in the NFTs game, let’s dive into NFT liquidity pools.
What Are AMM NFTs?
To understand NFT liquidity pools, you first need to know what AMM NFTs are. Automated Market Maker (AMM) Non-Fungible Tokens (NFTs) are a new type of NFT trading that utilizes automated market makers to create liquidity pools for NFTs. Unlike traditional NFT trading, which relies on buyers and sellers to agree on a price, AMM NFTs use mathematical algorithms to automatically determine the price of an NFT.
AMM NFTs have several advantages over traditional NFT trading, including increased liquidity, lower transaction fees, and the ability to trade NFTs without a central authority. Yet, they also have some drawbacks, such as potentially lower profits and the risk of impermanent loss. Further in this article, we will dive more into the pros and cons of AMM NFTs and how they hold a place in the market despite their risks. But first, let’s understand how AMM NFTs function.
How Do AMM NFTs Work?
AMM marketplaces enable you to establish liquidity pools with pairs comprising of your preferred NFT and the marketplace’s supported cryptocurrency.
When a user wants to buy or sell an NFT, they can do so by depositing tokens (fungible for buying, non-fungible for selling) into the liquidity pool. Then, AMM uses an algorithm called the ‘bonding curve’ to set the price of the NFT. This system sets the price based on the ratio of the tokens in the pool, and it is adjusted continuously based on supply and demand. There are two main types of bonding curves used by AMM NFT platforms:
Linear Curve: Every time an NFT is purchased from the pool, its price is raised by a set amount. Similarly, every time an NFT is sold to the pool, its price lowers by the same flat amount.
Exponential Curve: When an NFT is purchased from the pool, the price is increased by a specified percentage. Consequently, every time an NFT is sold to the pool, its price lowers proportionally.
Both types of bonding curves ultimately eliminate the need to wait for a buyer to agree to your price. This allows you to sell your NFTs immediately while earning trading fees from your pool. But as with every investing tool, there are advantages and disadvantages.
NFT AMMs VS NFT Marketplaces
To know if NFT AMMs fit your needs and goals better than traditional NFT marketplaces, it is interesting to compare them. Both carry their own pros and cons.
While NFT marketplaces allow users to buy and sell NFTs at a fixed price, NFT AMMs provide a more dynamic and efficient way to trade NFTs. In a marketplace, sellers set the price for their tokens, and buyers must pay that price to acquire them.
However, as explained, in an AMM, the price is determined by the ‘bonding curve’ algorithm, which continuously calculates NFT prices based on supply and demand. On one side, this allows AMMs to have a more flexible and fluid market. On the other side, there is a risk that your NFT will be sold below its floor price. Thus, there is a chance you won’t recover your initial investment. While this can be a risk, it doesn’t mean it is necessarily a bad thing if used in the right circumstances. Let us explain.
To fully take advantage of AMM NFTs and traditional NFT marketplaces, you need to look at them as tools that fulfill distinct purposes. They are both essential services in the NFT market in different ways.
For example, if you need to sell your NFT quickly, an AMM NFT platform can help you achieve that goal. You might have to sell it below the floor price, but this approach will resolve the liquidity issue. AMM NFTs platforms are better suited for floor NFTs or common NFTs, due to the risk of selling for a lower price.
However, if you are not in a rush to sell your NFT and you are open to waiting for a buyer to accept your asking price, then traditional NFT marketplaces are a better fit. While it might take some time to sell your NFT, you will be able to set your preferred price. This method is suitable for selling rare pieces of an NFT collection, such as Blue Chip NFTs, which are often valued way above the floor price.
Thus, the NFT industry can benefit from these two categories of platforms existing simultaneously, as both provide advantages to the NFT community advantages. Ultimately, they fulfill different purposes in different situations and are both needed.
Types of NFT Liquidity Pools
Finally, now that you understand AMM NFT platforms, let’s dive into their core feature – liquidity pools. Just like liquidity pools in crypto trading, NFT liquidity pools are a collection of funds locked in a smart contract that facilitate decentralized trading, lending, and more. They allow users to instantly swap between two types of assets. In the case of NFT liquidity pools, you can swap NFTs for a cryptocurrency used by the platform, or vice-versa.
There are two main types of NFT liquidity pools:
NFT Staking Liquidity Pools
This type of liquidity pool allows users to support a given NFT project by providing capital to it. Then, these provided funds are often used as collateral for the creation of a new token that represents the invested value. Subsequently, the tokens are minted and disbursed automatically to the NFT owners as a reward. Thus, they not only allow new NFT projects to raise funds from supporters but also for these supporters and NFT owners to gain rewards.
Trading Liquidity Pools
A Trading Liquidity Pool operates in a quite similar manner to a regular Liquidity Pool. Thus, trading liquidity pools allow users to trade their tokens without the need for a conventional counterparty. Instead, users deposit their tokens into the pool, which creates a reserve of liquidity that buyers and sellers can use to trade NFTs. In other words, you will be trading against the liquidity in the liquidity pool without the need to have a buyer or seller at that moment agreeing to the transaction. The transaction only needs adequate liquidity to happen, with the activity and pricing being handled by the algorithm.
Best AMM NFT Platforms
Got interested in NFT liquidity pools and want to start experimenting and investing with them? Here are some of the best AMM NFT platforms available today:
This decentralized AMM platform enables users to trade NFTs and other digital assets. It offers a simple and user-friendly interface that makes it easy for anyone to use. SudoSwap is built on top of the Polygon network, which provides fast and cheap transactions.
This platform is a decentralized exchange that provides liquidity pools for NFTs, tokens, and other assets. It is built on the Hade Protocol and uses the Proof-of-Liquidity algorithm to incentivize liquidity providers. HadeSwap offers low fees and fast transaction times, especially since is built on the efficient Solana network.
NFTPerp (vAMM NFT Platform)
NFTPerp is a virtual AMM (vAMM) platform that uses a novel pricing algorithm to offer traders high liquidity and low slippage. It allows users to trade perpetual NFTs, which are NFTs that represent the value of an underlying asset. The platform of itself is built on Arbitrum which uses vAMM (Virtual Auto Market Maker). Thus, nftperp is powered by an elevated version of this vAMM protocol approach, allowing the platform to offer a Dynamic Virtual Liquidity model, True Floor Price, and various safeguarding mechanisms. To learn more about NFTperp’s vAMM NFT platform, take look at this article. You can check the NFTperp Discord for more information on the other many features we offer.
NFT liquidity pools are an exciting development in the industry, especially due to the illiquid nature of non-fungible tokens. They offer a decentralized and automated way to trade tokens, as well as provide liquidity backers with a way to earn rewards. While it is important to consider the risks and understand when to use this powerful tool, NFT liquidity pools are definitely a game changer in the industry. As the NFT market continues to grow, we can expect to see more innovation in the area of NFT liquidity pools.
To learn about more ways to access liquidity and rewards in the NFT ecosystem, check out other articles about NFT financialization and more.