Committing Capital to Liquidity Pools
A liquidity pool holds reserves of two tokens and enables swapping between them. The pool, also known as a decentralized exchange or DEX, guarantees there is always a buyer when someone is looking to sell and a seller when someone is looking to buy. In exchange for this service, the pool collects a small fee on each swap.
Liquidity Providers (LPs) supply these reserves by depositing their own tokens, and in return, earn a share of the pool's transaction fees. In Uniswap v2 pools, LPs deposit equal dollar amounts of the two tokens in order to add to the DEX pool's reserves. For example, to provide liquidity to the GLW/USDC pool when GLW is at $10, a liquidity provider could deposit 50 GLW tokens ($500 worth) plus 500 USDC tokens ($500 worth). Once these tokens are added to the DEX pool, they become available to be bought and sold by people looking to exchange one token for another.
Constant Product Market Making
Liquidity pools have the most liquidity available for all potential buyers or sellers when they hold equal dollar values of each asset, as this allows pools to handle the largest possible token swaps in either direction.
When the pool maintains equal value of each token, the ratio of tokens in the pool determines their respective prices. For example, if the pool has 100 GLW and 1,000 USDC, then each GLW is worth 10 USDC (1000/100 = 10). This ratio tells us the price: buying 1 GLW costs roughly 10 USDC. Conversely, GLW sellers receive 10 USDC per GLW that they sell.
When someone exchanges tokens with the pool, they change the quantity of each token in the pool. For example, if an individual were to buy GLW with USDC, they add USDC to the pool and remove GLW from it. This changes the ratio of GLW to USDC, since the pool now has more USDC and less GLW. To maintain equal value of each token, the price of GLW must increase, since there are fewer GLW tokens per USDC tokens in the pool.
This also means that an LP position effectively functions as a portfolio that continuously rebalances to maintain equal values of each asset. For example, when LPing in the GLW/USDC pool, if GLW appreciates relative to USDC, the portfolio has sold GLW and bought USDC. If GLW falls, it does the opposite: buys GLW and sells USDC.
This rebalancing is automated via the pool's core equation: x · y = k, where x is the quantity of token X, y is the quantity of token Y, and k is a constant product that the pool maintains. In the GLW/USDC pool example, x would be the quantity of GLW and y would be the quantity of USDC. Whenever someone makes a swap, the pool enforces that any exchange of tokens results in the quantities of both tokens held in the pool adjusting to keep this product constant.
For example, when someone buys GLW with USDC, they add USDC to the pool (increasing y) and k must remain constant, so x must decrease. The amount that x decreases is the number of GLW tokens that the user receives, and the amount that y increases is the number of USDC tokens that the user pays. The GLW price in terms of USDC is y/x, which, per the above example, is 10 USDC per GLW token. This mathematical constraint ensures that as users exchange tokens, the pool automatically adjusts prices to maintain balance.
Understanding an LP's Portfolio
LPs keep some exposure to the price movements of each token relative to one another, but the exposure is different than if they were to just hold fixed quantities of each token.
Suppose a user Alice has $500 worth of GLW and $500 worth of USDC; at a GLW price of $10, this means she holds 50 GLW and 500 USDC. Instead of simply holding these tokens idle in her wallet, she may consider depositing these tokens in a GLW/USDC pool in order to start earning trading fees. At first glance, this may seem like an obvious productive use of her token holdings (they are sitting idle in her wallet anyway!), but there are some conditions under which Alice would be worse off from acting as an LP.
Consider a scenario in which she deposits her 50 GLW and 500 USDC in the GLW/USDC Uniswap pool, and while her tokens are providing liquidity, GLW increases from $10 to $40, experiencing a 4x price appreciation. Had Alice not LP'ed in the pool, and simply held her 50 GLW and 500 USDC in her wallet, her total holdings would be valued at $2500 (50 GLW x $40 + 500 USDC). However, because she LPed in the Uniswap pool, her holdings were constantly rebalanced to hold equal value amounts of GLW and USDC. Therefore, when GLW's price increased from $10 to $40, the pool rebalanced her token holdings to 25 GLW and 1,000 USDC ($1000 of GLW and 1000 USDC). Her total holdings still increased in value following GLW's price increase, but less than had she simply held her tokens.
This is because the pool automatically rebalanced through supporting trading activity, selling GLW as it rose and buying USDC. Alice ended up with less of the appreciating asset and more of the depreciating one, as the constant rebalancing commits LPs to selling in up markets and buying in down ones, capturing only a portion of the full price movements.
Impermanent Loss
Impermanent loss is the difference between the LP's portfolio value versus holding assets outside the pool following price movements.
In the above example, the LP originally deposited 50 GLW and 500 USDC, and when GLW's price increased from $10 to $40, the pool automatically rebalanced her position to 25 GLW and 1,000 USDC, worth $2,000 total. As demonstrated above, if she had simply held her original deposit outside the pool, she'd have $2,000 in GLW plus $500 in USDC, totaling $2,500. The $500 difference ($2000 vs $2500) represents a 20% impermanent loss.
Consider the opposite scenario: if GLW price falls from $10 to $2.50 (a 4x decline), the pool rebalances to maintain equal dollar values, and the LP position would adjust to approximately 100 GLW and 250 USDC, worth $500 total ($250 in GLW + $250 in USDC). However, simply holding the original 50 GLW and 500 USDC outside the pool would be worth $625 ($125 in GLW + $500 in USDC). The $125 difference also represents a 20% impermanent loss, which is the same percentage loss as when the price increased by 4x.
The general result is that impermanent loss is symmetric. Whether GLW price doubles versus halves, or quadruples versus declines by 4x, the LP faces the same loss when compared to holding the same tokens outside the pool. This loss occurs in both directions because the pool is always rebalancing away from whichever asset is performing better.
Incentivized Liquidity
Protocols benefit from deep liquidity pools with substantial token reserves; participants can make large swaps with minimal price impact, because deep liquidity allows the pool to maintain its x * y = k equation while absorbing significant trading volumes without dramatic price swings. This creates an attractive environment where new participants can easily acquire tokens at stable prices, existing holders can adjust positions cost-effectively, and the overall ecosystem can operate with minimal frictions.
As a result, projects may benefit from rewarding early LPs with token incentives to attract liquidity reserves. The simplest strategy is to distribute tokens to LPs proportional to their share of the liquidity pool. This is straightforward but tends to attract mercenary capital that exits when token rewards decline. Time-weighted rewards offer a more incentive-aligned approach, increasing token reward share with LP position duration. For example, a provider who maintains their position for 100 consecutive days might earn twice the daily rate compared to someone who enters and exits after ten days. This encourages stability by rewarding commitment while still allowing flexibility to exit. The longer an LP stays, the higher their effective reward rate.
These incentives serve a practical purpose: they improve LP returns and help pools to maintain sufficient liquidity for the broader ecosystem to benefit from a more stable token environment.
The LP Decision Framework
LPs benefit from providing liquidity in pools that have high trading volume since more trading volume generates more trading fees. They also benefit when token prices are less volatile, since less volatility means smaller price swings which lead to lower impermanent losses. Additionally, token incentives for LPing can provide strong motivation for consistent liquidity provisioning even during periods when fee income alone might be insubstantial.
Therefore, the main factors LPs consider are trading volume, price volatility, and the presence of external incentives (often token incentives). Ultimately, the decision comes down to whether expected returns are greater than potential losses. To illustrate: when one token in a pair experiences a 4x price movement (like Alice's example), LPs experience approximately 20% impermanent loss, meaning they would need their combined trading fees and token rewards to exceed 20% over the same period to make the position worthwhile.
The Glow Pool
Well-informed liquidity provisioning comes down to understanding trade-offs: LPs take on the risk of impermanent losses in exchange for steady fee income and potential token rewards. While impermanent loss is an inherent risk of providing liquidity, consistent trading fees and token incentives can make this trade-off worthwhile for potential LPs.
For Glow specifically, the GLW/USDC pool represents an opportunity where an LP's individual profit aligns with project success. Early liquidity providers stand to benefit from consistent fee income, GLW token incentives, and their role in building the critical financial infrastructure that enables clean energy adoption at scale. The key factors discussed in this article, including current trading volumes and available incentives, can be viewed directly in the Glow App to help potential LPs make informed, data-driven decisions.