Liquidity Pools vs Traders
In this lesson, we discuss liquidity providers who earn both from trader losses and from the fees traders pay when opening their positions. As a reminder, on centralized exchanges such as major platforms, traders use leverage, and the exchange itself lends them additional capital. In simple terms, leverage allows a trader to increase the size of their position using borrowed funds.
For example, you may have one thousand dollars and want to use more capital to increase the potential profit of your trade. You can borrow an additional five thousand dollars from the exchange to open a position — to buy Ethereum or Bitcoin and go long. This increases risk, but essentially leverage is simply an expansion of the deposit used in the trade on a centralized platform.
A similar mechanism exists in DeFi, but only on specific decentralized exchanges — not the ones discussed in the previous lesson, which operate with version-2 and version-3 liquidity pools. That is one category of exchanges. There is another category — platforms that allow traders to connect their wallet and start trading Bitcoin, Ethereum, or other assets without going through centralized verification and without submitting personal data. Everything is fully decentralized. One such exchange is GMX.
But the question arises: if a decentralized exchange does not hold its own funds, where does the liquidity for leverage come from? This is where liquidity providers come into play.
What do they do? They hold a basket of two assets — this may be Bitcoin, this may be Ethereum, or it may be stablecoins. In today’s example, we consider a basket composed of stablecoins and Ethereum. Liquidity providers deposit these assets into a trading pool, and traders can borrow from this pool when opening leveraged positions.
We receive the fees that traders pay. The platform charges a fee for opening and closing a position, and a portion of these fees is distributed to liquidity providers. In addition, we earn from trader losses. If traders lose money, a share of these losses is allocated to liquidity providers — proportionally to their share of the liquidity pool.
But naturally, there is also a risk. We lose money when traders earn money. This is a game in which we are on the side of chaos — similar to a casino, where chaos almost always wins. This is the case where we can join the “money-extraction machine” that takes funds from market participants. Over long periods, traders lose money — most of them — and we can position ourselves against them.
What do traders do on GMX? They open long or short positions on the assets they are interested in, and they borrow leverage from liquidity providers. If we supplied liquidity in Bitcoin, traders can take part of that Bitcoin from our pool to open long or short positions. The same applies to Ethereum or stablecoins.
Traders also pay fees for opening and closing positions — part of these fees goes to us as liquidity providers. When traders lose money, we earn because their losses are redistributed among all liquidity providers. When traders earn money, we take a loss, because a successful trader withdraws profits from the liquidity pool. We act as the counterparty — the opposite side of the trade.
Here is a clear statistic showing that over long periods traders lose far more often than they win. Since the liquidity pools on GMX became available, traders have lost around fourteen million dollars. Yes, there were periods where traders earned more than they lost, but the overall graph is trending downward. It will likely continue decreasing — trader losses will keep growing.
All these lost funds — fourteen million dollars — were distributed to liquidity providers, who received around seventy percent of trader losses. And this does not even include fees. Traders pay fees regardless of whether they win or lose — for both opening and closing trades. This is why returns are genuinely strong.
The two main liquidity pools on GMX are Bitcoin and Ethereum. In these pools, we hold a basket of two assets and earn from trader losses, from trading fees, and from asset appreciation. This is an excellent option for allocating capital. It is reasonable to keep a small portion of your portfolio here.
Now let’s review the advantages of BTC+ETH liquidity pools.
First, you earn from trader losses and fees.
Second, you maintain a balanced BTC/ETH position. This position grows with the market.
When the market falls, the drawdown is softened.
Also, this strategy requires no active management.
Now to the disadvantages. The BTC+ETH liquidity position grows more slowly compared to holding pure Bitcoin or pure Ethereum in a cold wallet. Why? Because half of your position is in ETH and half in BTC, not fully in one asset. This smooths drawdowns but reduces upside potential. In reality, this is not a disadvantage — it is simply a structural characteristic of such pools.
This point is very important. People often start comparing liquidity pools with simply holding bitcoin and ethereum. The problem is that no one ever knows where the market will go. You can compare it in the opposite direction as well: liquidity pools perform excellently in a falling market because they smooth out losses thanks to the fact that half of the position consists of stablecoins. On a rising market, they perform less aggressively, but still very well, because half of the pool consists of bitcoin or ethereum, which are volatile assets with strong growth potential.
This makes liquidity pools an excellent position for any long-term investor, considering that we earn not only from market growth, but also from fees and trader losses. This is extremely important. It is obvious that in a strong bull market simply holding bitcoin is more profitable, and in a bear market you can exit into stablecoins and avoid losses. Everyone understands this.
The problem is that no one knows when the market will start falling or when it will start rising. We can only rely on long-term horizons and allocate capital rationally. Therefore, do not listen to people who claim that GMX pools are inefficient or “make less than something else”. It is always easy to invent a benchmark and compare results to something chosen after the fact.
Take bitcoin. If it grew by one hundred percent in a year, someone will say: “If we had invested in this altcoin, we would have earned more.” This is a flawed way of thinking. It is dangerous. We are not trying to play the game of predicting market movements. We cannot know. This is why GMX-style pools should always be part of a beginner’s portfolio.
Now the second risk: the possibility that traders may start earning more than they lose. The chart shows that such moments indeed occurred. In the short term, this can happen. But over the long run, according to the data, traders lose more than they earn with almost ninety-nine percent probability. This is clear from statistics. Therefore, this risk should not cause concern; it should simply be acknowledged. The principal deposit can decrease if a trader makes a large profit — and this will be reflected on the chart. But over long distances, traders still lose more.
The platform also offers pools consisting only of bitcoin or only of ethereum. Earlier we discussed the BTC + stablecoin pool, which provides a balanced position. But there are also liquidity pools that hold only bitcoin or only ethereum. In these pools, we capture the full growth potential of bitcoin and the full growth potential of ethereum during bull markets.
There are no stablecoins in these pools. Therefore, in a falling market the drawdown in dollar terms will be larger because the entire position is volatile. But in a rising market, the returns will be higher because the amount of bitcoin and ethereum increases over time — we earn both trading fees and trader losses.
However, the yield on such pools will be significantly lower than on liquidity pools paired with stablecoins.
Here it is very important to divide decentralized exchanges into two main categories:
Category 1 — Classic DEX
Uniswap, PancakeSwap, Curve, SushiSwap, etc.
They use version-2 and version-3 liquidity pools.
We earn fees and benefit from asset growth.
Trader profits/losses do NOT affect our deposit.
Category 2 — Futures DEX
GMX, MUX, Gains Network.
We earn fees from leveraged trading activity.
Trader profits/losses DO affect our deposit.
We earn a lot from trader losses over long horizons.
To summarize:
- Classic DEX: we earn swap fees + asset appreciation.
- Futures DEX: we earn trading fees + trader losses + asset appreciation.
- If traders win, liquidity providers lose. If traders lose, liquidity providers win.
In the next lesson, we will open our first position on a classic DEX — most likely Uniswap — where I will show how to provide liquidity in stablecoin pools, explain the difference between version-2 and version-3 pools, and demonstrate the full process in practice.
These materials are created for educational purposes only and do not constitute financial advice.