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Why Become a Liquidity Provider on Biatec DEX?

· 10 min read
Ludovit Scholtz
Ludovit Scholtz
Biatec CEO & Founder

I recently received a very direct question from a community member: "I became a liquidity provider just now, and in 1 day I lost 5% of my capital. So what is so good about it?"

It is a fair question, and it highlights the most common misunderstanding about Decentralized Finance (DeFi). Liquidity Provisioning (LPing)—especially in a Concentrated Liquidity AMM (CLAMM) like Biatec—is not a savings account. It is an active investment strategy that functions like an automated trading bot.

If you treat it like a passive "hodl" strategy without understanding the mechanics, you can indeed lose value relative to just holding the tokens. But if you understand the use cases, it becomes one of the most powerful tools in DeFi.

Here is why sophisticated investors choose to provide liquidity on Biatec, and when you should avoid it.

The Mechanic: You Are the Market Maker​

In traditional finance, market makers are massive institutions that quote buy and sell prices for assets. They earn a small spread on every trade. In Biatec, you are the market maker.

When you provide liquidity, you are essentially saying: "I am willing to sell Asset A as it goes up in price, and buy Asset A as it goes down in price, within this specific range."

In exchange for providing this service, you earn trading fees. 🚀 The goal is for the fees to outweigh any "Impermanent Loss" (the difference between holding the tokens and providing liquidity).

Traditional AMM vs. Concentrated Liquidity (CLAMM)​

To understand why Biatec is different, we need to compare it to traditional AMMs (like PactFi or Tinyman or Uniswap v2).

In a Traditional AMM, your liquidity is spread out across every possible price, from 0 to infinity. This means 99% of your capital is sitting idle, waiting for the price to drop to $0 or go to $1,000,000. It's incredibly inefficient.

In a Concentrated Liquidity AMM (CLAMM) like Biatec, you choose a specific price range (e.g., $0.90 - $1.10). Your capital is only used when the price is within that range. This makes your capital up to 4000x more efficient, meaning you earn significantly more fees with the same deposit.

The Restaurant Analogy​

Imagine that you run a restaurant.

  • The Traditional AMM Restaurant cooks a bit of every dish on the menu all day long, even when nobody orders it. Most of that food sits cold and is wasted, and you earn less profit because your resources are spread too thin.
  • The Biatec DEX Restaurant is smarter. We cook and prepare food only at the tables where customers actually sit and order. No wasted ingredients, no empty preparation.

Because of this, we serve faster, waste less, and make more money from the same kitchen.

Use Case 1: The Forex & Stablecoin Yield Farmer (EUR/USD)​

Scenario: You hold Euros (e.g., EURS) and Dollars (e.g., USDC). You expect the exchange rate to fluctuate slightly but generally stay stable.

Strategy: You provide liquidity in a tight range around the current exchange rate (e.g., 1.05 - 1.10 EUR/USD).

Why it works:

  1. High Efficiency: Because Biatec is a CLAMM, you concentrate your capital exactly where the trading happens. You earn significantly more fees than on a traditional AMM (like TinyMan V1) where capital is spread from $0 to infinity.
  2. Mean Reversion: Forex pairs tend to oscillate. As the price moves up and down within your range, you are constantly selling high and buying low, capturing fees on every swing without your portfolio value drifting too far in one direction.

Use Case 2: The Peg Believer (GoBTC/WBTC)​

Scenario: You hold two versions of the same asset, for example, goBTC (Algorand-wrapped Bitcoin) and wBTC (another wrapped Bitcoin variant).

Strategy: You provide liquidity in a 1:1 range (or very close to it).

Why it works:

  1. Minimal Risk: Since both assets represent Bitcoin, their price relative to each other should barely move. The risk of Impermanent Loss is near zero.
  2. Pure Yield: You are essentially earning free Bitcoin (in the form of fees) just for letting traders swap between the two wrappers. This is often safer than lending protocols because you retain custody of the assets in the pool contract rather than lending them out to borrowers who might default.

Use Case 3: The Range Trader (Gold/USD)​

Scenario: You hold Gold (e.g., PAXG) and USDC. You think Gold is currently range-bound between $2,500 and $2,700.

Strategy: Instead of setting a limit order, you provide liquidity across the $2,500 - $2,700 range.

Why it works:

  • Monetizing Volatility: If Gold chops sideways for months, a holder makes $0 profit. A liquidity provider, however, collects fees every single day that volatility continues.
  • Automated DCA: If the price drops to $2,500, your position automatically converts to Gold (buying the dip). If it rises to $2,700, it converts to USDC (taking profit). You are automating a "buy low, sell high" strategy while getting paid fees to do it.

When is it NOT good to be a Liquidity Provider?​

The user who lost 5% in a day likely fell into one of these traps. You should not LP if:

  1. You expect a massive moonshot: If you think a token is going to do a 10x, do not LP. As the price skyrockets, the pool will sell your tokens for USDC (or ALGO) all the way up. You will end up with a pile of stablecoins while the token continues to fly without you. You would have made more money just holding.
  2. The pair is extremely volatile (Shitcoins): If a token crashes 50% against ALGO, the pool will buy that falling knife for you. You will end up holding 100% of the worthless token.
  3. You set the wrong range: In a Concentrated Liquidity AMM, if the price moves outside your range, you stop earning fees entirely and are left holding 100% of the underperforming asset.

The Elephant in the Room: Impermanent Loss​

The "loss" the user experienced is technically called Impermanent Loss (IL), though a better term is Divergence Loss. It represents the difference in value between holding your tokens in a wallet versus providing them to a liquidity pool.

When the price of one asset in the pair changes significantly compared to the other, the pool automatically rebalances your portfolio:

  • If Asset A goes up, the pool sells it for Asset B (you end up with less of the pumping asset).
  • If Asset A goes down, the pool buys more of it (you end up with more of the dumping asset).

In both cases, your total value in dollar terms might be lower than if you had just held the original amounts. This loss becomes "permanent" if you withdraw your liquidity while the price is still different from your entry price.

How to Solve (or Mitigate) Impermanent Loss​

While you cannot eliminate IL entirely in volatile pairs, you can manage it. Here are the best ways to solve the problem:

1. The "Fee Buffer" Solution (Time is your friend)​

In a CLAMM like Biatec, your capital efficiency is significantly higher than traditional AMMs. This means you earn fees much faster. The goal is to stay in the pool long enough for the accumulated fees to exceed the impermanent loss.

  • Solution: Don't panic withdraw after 1 day of volatility. Allow time for trading volume to generate fees that cover the initial divergence.

2. Choose Correlated Pairs​

As mentioned in the "Peg Believer" use case, IL only happens when prices diverge.

  • Solution: Provide liquidity for pairs that move together, like ALGO/xALGO, USDC/EUR, or wBTC/goBTC. If the price ratio stays stable, IL is effectively zero, and you keep pure profit from fees.

3. Adjust Your Range (Active Management)​

Biatec allows you to set custom price ranges.

  • Solution: If you are bullish, you can provide liquidity in a range above the current price (effectively a limit sell order). If you are bearish, provide it below. By aligning your range with your market outlook, you turn the rebalancing mechanism into a feature (taking profit or buying the dip) rather than a bug.

4. Hedging (Advanced)​

Professional market makers often hedge their exposure.

  • Solution: If you provide liquidity for ALGO/USDC, you are "long" ALGO. You could open a small short position on a perpetual futures exchange to offset the price risk. This makes your position "Delta Neutral," meaning you don't care if the price goes up or down; you only care about collecting fees.

5. Know When to HODL​

If you believe a token is about to explode in value (e.g., +50% in a week), do not LP.

  • Solution: Just hold the token. Liquidity provisioning is a strategy for sideways or slowly trending markets, not vertical pumps.

Risk Appetite: Small Investors vs. Investment Funds​

Understanding your own risk profile is critical when deciding how to use Biatec. The strategy for a retail user with $1,000 is often completely different from a fund managing $10,000,000.

Small Investors & Beginners (High Risk / High Reward)​

Small investors often come to DeFi looking for "moonshots." They want to turn $100 into $1,000.

  • Typical Behavior: They chase the highest APR pools, often involving volatile "meme coins" or new, unproven tokens.
  • The Risk: These pools have massive volatility. While the fees might be high, the risk of the token price crashing to zero (Rug Pull or just bad tokenomics) is huge.
  • The Reality: For this group, holding (HODLing) the token is often better if they believe in the project's long-term growth. LPing caps their upside (selling early as price rises) and exposes them to 100% downside if the price crashes.
  • Advice: If you are a beginner, start with small amounts in stable pairs (like ALGO/USDC) to learn the mechanics before jumping into high-volatility pools.

Investment Funds & Risk-Averse Investors (Capital Preservation)​

Institutional investors, treasuries, and sophisticated funds prioritize not losing money over making 100x returns.

  • Typical Behavior: They gravitate towards "boring" pairs: Stablecoin/Stablecoin (USDC/EUR), Liquid Staking Tokens (ALGO/xALGO), or major asset pairs (wBTC/goBTC).
  • The Strategy: They are happy with a consistent 5-15% APY because it beats traditional bank rates. They often use Delta Neutral strategies (hedging their exposure) so that market movements don't affect their principal.
  • The Reality: For them, Biatec is a tool to earn yield on idle assets that would otherwise sit in a wallet earning 0%. They are "renting out" their assets to the market.
  • Advice: Focus on high-volume, low-volatility pairs. The goal is steady cash flow from fees, compounding over time, with minimal drawdown risk.

Conclusion​

Liquidity provisioning on Biatec is not a "set it and forget it" savings account. It is a professional-grade tool for earning yield on assets you plan to hold, or for automating entry and exit strategies.

If you lost 5% in a day, it likely means the market moved significantly against your position, and the "loss" is the rebalancing of your portfolio into the asset that dropped in value.

However, for those who identify stable pairs, correlated assets, or range-bound markets, Biatec offers the most capital-efficient way on Algorand to put your assets to work.