Becoming a Market Maker: Why LP’s Need ETH to Back Their wLEO

A lot of users have been talking about the need to have Ethereum along with their wLEO when providing liquidity to the Uniswap pool. This clip and the graphical guide at the end of this post should help explain the role of a liquidity provider in more depth.

Show Notes:

One of the top questions I’ve seen recently is: do I need ETH to provide liquidity to the wLEO Uniswap pool and earn a share of the 300,000 LEO bounty?

In short: yes, you need to have 50–50 wLEO-ETH to participate as a Uniswap liquidity provider. If you want to provide $100 worth of LEO to the pool (as wLEO), you would also need to provide $100 worth of ETH (totaling your LP investment to $200).

I describe it in this clip from the roundtable as understanding what it means to be a market maker. By providing liquidity to the wLEO-ETH pool on Uniswap, you are becoming a market maker which means that when someone buys wLEO with the pool (by swapping ETH into wLEO), the pool — which you own a fractional share of — is providing the wLEO and receiving the ETH as payment.

This is how nearly every market in the world works: for each buyer, there is a seller. For each seller, there is a buyer. As a liquidity provider, you’re becoming a market maker for both sides of every trade. When someone trades either wLEO for ETH or ETH for wLEO, you’re providing liquidity for the other side of their trade and collecting fees for doing so.

Here’s a simple example of how pooling works on Uniswap:

For our example, let’s say that the pool is currently 0.90 ETH and 2,700 wLEO. The ETH price is currently $360 and the mechanics of Uniswap dictate the wLEO price by taking the value of the total ETH in the pool ($324) and dividing it by the total amount of wLEO tokens in the pool.

0.90 ETH ($324) / 2,700 wLEO = $0.12 / wLEO

You are an aspiring Liquidity Provider. You come in and you invest 300 wLEO in the pool. With Uniswap, you need to match that 300 wLEO with an equivalent value in ETH. Since the pool price of wLEO is currently $0.12 USD/wLEO, you need 0.10 ETH to match your 300 wLEO.

300 wLEO = $36 (300 * $0.12)

$36 / $360 = 0.10 ETH required to match

With your investment into the pool, the total liquidity now looks like this:

I adopted a Uniswap Graphic to fit our example with wLEO

Your investment into the pool (0.10 ETH and 300 wLEO) means that you now own 10% of the total liquidity pool (1 ETH and 3,000 wLEO).

Now I come in and swap $50 worth of ETH (0.139 ETH) for $50 worth of wLEO (416 wLEO) (trading my ETH for wLEO).

The total liquidity pool has now changed since I deposited ETH and withdrew wLEO from it. Now there is more ETH in the pool and less wLEO. Uniswap acts accordingly by changing the value of wLEO, since there is more ETH backing each wLEO.

Depositing 0.139 ETH into the pool allows me to withdraw 416 wLEO. Changing the liquidity pool balance to 1.139 ETH and 2,584 wLEO.

Due to the change in balance, the wLEO price is now $0.158 — since there is 1.139 ETH backing 2,584 wLEO.

$360 (ETH price) * 1.139 = $410.04. $410.04 / 2584 wLEO = $0.158 / wLEO

Nobody has added or removed liquidity since your last deposit. This means that you still own 10% of the total liquidity pool. However, since I just swapped ETH for wLEO, the total balance of the liquidity pool has changed. This means that instead of owning 0.10 ETH and 300 wLEO, you now own 0.1139 ETH and 258.4 wLEO (10% of the new total LP balance).

Obviously, there is quite a bit going on behind the scenes of a Uniswap liquidity pool. The good news is that as a liquidity provider — all you really have to do is deposit 50/50 of each token into the pool and then sit back and collect fees. Once you’re done with being an LP (or want to change/reduce your position), then you can take the appropriate action and remove liquidity or add more to the pool.

As we also mention in the above clip — this seems a lot more complicated than the actions of being a part of it. To participate doesn’t necessarily mean that you need to understand the nuances of the mechanics I wrote about here, but I personally believe it’s a good idea to understand them at some level so you’re not walking blindly into a new situation.

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