Role of Liquidity Pool in Stabilizing Value of Token

Abstract

Liquidity pools play a crucial role in stabilizing the value of tokens, especially within the context of decentralized finance (DeFi) ecosystems. One of the primary mechanisms through which liquidity pools contribute to stability is by facilitating an arbitrage mechanism. Buying is made when token is undervalued. On other hand selling is made when it's overvalued. This arbitrage activity is made possible by the existence of liquidity pools, where traders can execute these transactions directly on decentralized exchanges. The constant pressure from arbitrageurs helps to bring the token's value back to its target peg, fostering stability. Furthermore, liquidity pools respond dynamically to changes in supply and demand for the token. As demand for the stablecoin increases, users swap other assets for it, leading to a rise in its price. Conversely, when demand decreases, users swap the stablecoin for other assets, causing its price to decrease. Liquidity pools adjust to these changing dynamics by automatically rebalancing the composition of assets in the pool, aligning with market conditions. This responsive behavior contributes to the stable value of the token, as the liquidity pool adapts to fluctuations in demand and supply. This research has discussed liquidity pool creation process of Two NFT tokens (METANFT, 9NFTMANIA) in world famous decentralized exchanges such as Pancake swap and Icecream swap.