All You Need to Know about DeFi and Using the Common AMM

Let’s take a short crash course on DeFi and some key terms associated with this sector of Web3 while also explaining some of the most basic functions of the Common DeFi that will have you swapping, providing liquidity, and farming by the time you get through this article. 

What’s an AMM and How it Works

AMMs, or automated market makers, are a cornerstone of decentralized finance (DeFi). They are a type of decentralized exchange that allows digital assets to be traded in a permissionless and automatic manner. What makes them different from other types of exchanges is their reliance on market makers to provide liquidity for an asset. Instead of users trading with each other through order books, liquidity pools, and a mathematical formula ensure each asset’s price. Every user who provides liquidity takes part in this process, and profit is derived from the constant flux of users selling and buying the asset in question. Because of their design, AMMs keep the DeFi market up and running 24/7.

What are Liquidity Pools 

Liquidity Pools, otherwise known as LPs, are a crowdsourced cache of funds that exist on a decentralized exchange. They allow traders and borrowers to undertake many activities, such as swapping or farming (we’ll get into what these are in just a bit). LPs use algorithms and smart contracts to ensure the safety of users and the assets in question. Healthy decentralized exchanges rely on robust liquidity pools to ensure users can trade quickly and efficiently. 

What is Farming 

Farming is an investment strategy that involves investors providing crypto assets through liquidity pools to receive interest on the assets they have lent. The assets are sent to a smart contract that allows this type of activity. Farming is a way to incentivize users to provide liquidity ensuring a more robust and confident DeFi experience. However, caution must be taken as vulnerabilities in smart contracts, or price swings can affect the rewards a user may receive. 

What is Swapping

Another element of DeFi is swapping which is an automated method for transferring assets, allowing investors to exchange the tokens they currently own for different ones without relying on any central authority. Automated market makers are crucial for this service to work and use smart contracts to make it possible. The liquidity that makes swapping achievable is provided by the exchanges user base. 

Explaining Liquid Staking 

Proof-of-stake blockchains like Aleph Zero rely on users staking their assets in exchange for rewards to secure the network. Users can choose to participate in the network either as validators (by running a node) or as stakers, entrusting their chosen validator with their assets to continue securing the network. This is all well and good but traditional staking methods lock these assets up, effectively taking them out of the network’s economy. 

An upgrade with regards to staking is the invention of liquid staking, which allows users to stake their tokens and in exchange receive a newly minted token, that represents their claim of the tokens they delegated. They can use this new token to further trade or use other DeFi services, effectively unlocking liquidity for staked tokens and the ecosystem at large. 

Impermanent Loss and How to Minimize its Effect 

One of the most stress-inducing elements of providing liquidity to decentralized exchanges is the phenomenon of impermanent loss. This is a temporary decrease in the value of the assets provided by a user to a liquidity pool or through farming. The fluctuations in price experienced by users is a natural consequence of the algorithms governing liquidity pools that occur as a reaction to the movement in market price of two assets found in the pool. Users may be surprised to notice that through the impact of impermanent loss that they have suffered financial setbacks. 

However, the key word here is “impermanent,” as given enough time the pool will rebalance and users will most likely recuperate their losses. It is only a loss if the user withdraws their funds prematurely before this natural balancing act completes its cycle. Users are encourage to use impermanent loss calculators that can be found online to estimate their potential losses and use other best practices such as: 

• choosing pools with correlated assets, 
• Bearing in mind the transaction fee rewards, 
• diversifying liquidity across various pools, 
• Researching and understanding the influence of asset volatility.

Impermanent Loss in Numbers 

To fully comprehend impermanent loss, let’s imagine a scenario where you are a liquidity provider depositing 1 ETH and 100 DAI into a liquidity pool. In this automated market maker (AMM), the token pair must have equivalent value. For this example we’ll assume that the price of ETH is 100 DAI at the time of deposit, meaning that your deposit totals 200 USD.

The pool itselft also contains 10 ETH and 1,000 DAI from other providers, giving you a 10% share of the pool, meaning that the pools total liquidity is 10,000 USD. Now, if the price of ETH rises to 400 DAI, arbitrage traders will swoop in to balance the pool by adding DAI and removing ETH until the ratio reflects the new price.

Remember, AMMs determine asset prices based on their ratios in the pool, not order books. While the pool’s total value remains 10,000 USD, the asset ratio shifts. With ETH now at 400 DAI, the pool adjusts to 5 ETH and 2,000 DAI. When you withdraw your 10% share, you receive 0.5 ETH and 200 DAI, worth 400 USD. You’ve made a profit from your initial 200 USD deposit, right? But consider if you had simply held onto your 1 ETH and 100 DAI. Their new combined value would now be 500 USD.

This scenario illustrates that holding your assets might have been more profitable than providing liquidity, demonstrating impermanent loss. Though in this example the loss is minor due to the small initial deposit, impermanent loss can significantly impact larger deposits.

It’s important to note that this example does not account for the trading fees earned from providing liquidity. Often, these fees can offset impermanent loss, making liquidity provision profitable. However, understanding impermanent loss is essential before participating in a DeFi protocol.

Getting Started with Common 

Now that we got some basic DeFi terminology out of the way, we can briefly explain how to apply these concepts within Aleph Zero’s native AMM itself. 

Swapping 

Here is a breakdown of the steps to get started with swapping on the Common AMM.

1. Open the Common web app and click on the tab “Swap” to be brought to the swapping menu.
2. Click “Connect” to choose one of the supported wallets through which you will be swapping coins.
3. Once you choose your wallet, you will see a list of possible accounts with which you can interact with the app. Select one and connect it to the app.
4. Select the account you wish to use with the Common app.
5. Press the “Select a token” button in the “You pay” section of the Swap page to choose which token you will be swapping. You can search for tokens through the list or their name or address through the search bar.
6. Next, choose the token you wish to receive in the “You receive” section.
7. You will see a slider through which you will be able to choose how many tokens to swap and how many tokens you will receive. Below, you will see the “Network fee,” which will inform you how much the transaction will cost. After you do that, click “Swap.”
8. You will now need to sign the transaction.
9. Once signed, the transaction will be processed. You will then see the new balance of tokens and a transaction confirmation. Congratulations, you just swapped with Common! 

For a more comprehensive look into the process head over to the Common Knowledge Base to learn more about swapping tokens with Common. 

Alternatively check out the video guide titled “How to Swap Tokens” provided on the Common | The Private DeFi Suite YouTube channel. 

Providing Liquidity on Common 

Follow these steps to provide liquidity to the Common AMM. 

1. Click the “Pools” tab to see the list of available pairs.
2. On this page you will see the total value of the pool and of the two assets found in the pool. To add liquidity, click the “Add Liquidity” button on the right. Make sure you have in your wallet both tokens that you wish to add to the pool. 
3. A pop-up window will appear that will allow you to choose with the slider how much of your assets to add. You will also see the network fee below. Click “Add liquidity” to proceed.
4. A new window will appear, prompting you to sign the transaction. Please note, that this will look differently for everyone based on what extension they are using.
5. After the transaction is completed you will be able to see to the right your pool balance. If you wish to withdraw your assets you will be able to do so through the “Withdraw” button. Congratulations! You have now successfully added liquidity to Common!

For a more detailed overview on how to provide liquidity head over to the Common Knowledge Base to the section titled: Explaining Liquidity Pools. 

Alternatively check out the video guide titled “Adding Funds to Liquidity Pools” provided on the Common | The Private DeFi Suite YouTube channel. 

How to Farm 

To start your adventure with farming enter the “Pools” tab and choose a liquidity pool with an active farm. Remember to consider the APY of the various pools Common offers, the LP tokens accepted for farming, and the APY of the farm itself.

1. Once you’ve chosen a pool/farm of interest, deposit your crypto assets into the pool. After you add your funds, you will receive LP tokens.
2. Once you are part of a liquidity pool that provides farming capabilities, you can proceed with farming by clicking the “Start farming” button.
3. A pop-up will appear explaining your position on the farm and your accompanying assets, as well as a network fee for joining. To proceed, click “Start farming.”
4. Next, sign the transaction.
5. You are now farming! Although some yield-farming strategies do have lockup periods, Common’s farms do not. You can withdraw your LP tokens at a time of your choosing after which you’ll receive your share of rewards for the amount of time your LP tokens remained deposited. You can do this by clicking the “Stop farming” button.

A more thorough guide on farming can be found in the Common Knowledge Base in the section titled: How to Farm. 

Alternatively check out the video guide titled “How to Farm” provided on the Common | The Private DeFi Suite YouTube channel. 

The Common Staking Drops and The Common LP Drops Campaign 

As the Aleph Zero ecosystem is starting to deploy the Common AMM the team has decided to reward and incentivize the community for their patience and never-ending support by launching two campaigns. Here is a brief overview of what to expect: 

Common Staking Drops

The Common Staking Drops campaign aims to reward AZERO stakers and ecosystem participants for their role in safeguarding the network. These Drops will then be redeemable for CMN Tokens. The number of tokens you receive is dependent on your Effective Stake. To learn more about how to get involved and claim your share of the CMN tokens be sure to visit: 

Common Drops are coming: here’s how the rewards break down

Common LP Drops 

This campaign is reserved for those who provide liquidity on Common making them eligible to receive rewards that can be later redeemed for CMN tokens. To get involved go to the Pools tab in the Common AMM and provide liquidity for one of the pairs marked with the violet Common Drops badge. The farming will turn on automatically, enabling you to receive both AZERO and Common LP Drops.

To learn more about the Common LP Campaign be sure to read: 

Common Drops: provide liquidity, use farms, and get the LP Drops!

Unleashing the Ecosystem’s Potential with Common 

The team is excited to enter this new era of the Aleph Zero network that Common will surely facilitate. By offering users a private yet compliant method to conduct transactions in a non-custodial manner we are confident that Common will be an attractive option for both regular traders as well as those at the institutional level. This new period of growth we are entering is a product of the cooperation of the core team, projects building upon the network and most importantly the community. We hope you’re excited as we are for what’s coming next!