This section will explain the concept of liquidity in Caviar's shared pools and how it affects the trading of NFTs. Liquidity is crucial for the efficient functioning of the AMM algorithm, as it enables seamless trading and accurate price discovery.

Role of Liquidity Providers

Liquidity providers (LPs) play a vital role in shared pools by depositing NFTs and their associated reserve assets (e.g., ERC20 tokens or ETH) into the pool. These deposits create a market for users to trade NFTs without the need for a direct buyer or seller. In return for providing liquidity, LPs earn trading fees from swaps that occur in the pool they have contributed to.

Adding Liquidity to Shared Pools

To add liquidity to a shared pool, users follow these steps:

  1. Select the pool: Choose the appropriate shared pool based on the desirability of the NFT to be deposited. Pools are named according to the desirability group (e.g., floor, mid, rare, or grail) and the reserve asset (e.g., ETH).

  2. Deposit NFTs and reserve assets: Users deposit the NFTs they want to provide liquidity for, along with an equivalent value of the associated reserve asset. The amount of the reserve asset required is determined by the AMM algorithm, based on the pool's current state.

  3. Receive LP tokens: Upon depositing NFTs and reserve assets, users receive LP tokens representing their ownership share in the pool. These tokens can be used to claim trading fees earned or to withdraw the deposited assets later.

Impact of Liquidity on Shared Pools

Liquidity has a direct impact on the trading experience and price discovery in shared pools:

  1. Price stability: A higher liquidity level in a pool results in greater price stability, as the impact of individual trades on the overall price is minimized.

  2. Slippage: Adequate liquidity helps reduce slippage, which is the difference between the expected price and the executed price of a swap. Higher liquidity levels lead to less slippage, providing a better trading experience for users.

  3. Trading volume: Greater liquidity attracts more traders to the pool, as it allows for larger trades without significantly impacting the price.

  4. Trading fees: A higher trading volume results in more fees earned by liquidity providers, as they receive a percentage of each trade that occurs in the pool.

By contributing liquidity to Caviar's shared pools, users can facilitate a more efficient and seamless trading experience, while also earning fees from swaps. The desirability classifier and AMM algorithm work together to ensure accurate price discovery and a smooth trading process.

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