On decentralized exchanges, liquidity pools are used instead of traditional order books. On Uniswap, basically, you deposit a 50/50 ratio of 2 tokens in a pool and you receive a share of the pool in return, in the form of Uniswap’s pool token plus a percentage of the 0.3% fee on every transaction. One risk is that once others tap into the liquidity you deposited, your ratio of your pool share changes. So can deposit 10DAI and .025ETH and end up with 5DAI and .039ETH. If the price of ETH goes down, it wouldn’t be very nice to have a higher amount of it.
EDIT: I’d like to add that Uniswap has recently added a governance token (which is not the same as their pool tokens) that is given as a reward for providing liquidity on top of rewards from fees. This system is called “Liquidity mining”. More info: uniswap .org/blog/uni/. I would also like to know if this token is Sharia compliant.
In terms of liquidity pools, there can be several ways this can be deployed. Hence, it is very difficult to review the Shariah compliance of it in isolation.
Thank you for replying. There are many different implementations for liquidity pools, but is it possible to review the Shariah compliance of the way Uniswap handles them?
Wa alaykumu s-salam Mufti,
Sorry for any confusion, I am not asking to review any tokens. I am simply wondering about the permissibility of the model that decentralized exchanges run on.
From what I can see, the liquidity provider is basically purchasing a share of the liquidity pool. The share is represented by a special token.The provider gets to collect a percentage of the transaction fees in return. Sometime in the future, the provider can sell their share(denoted by their special liquidity token) to get the same $ value of the tokens they deposited in a different ratio than when they deposited them + money from transaction fees. Because the ratio is different, there is a chance that they could have made more money if they just held the tokens.[1] Many decentralized exchanges also have another token that is given as a reward for providing liquidity to their exchange on top of money collected from transaction fees. This token is separate from the liquidity token I explained earlier and can be sold at any time just like any other token without removing liquidity.
Is there anything questionable about this?
Shukraan Jazilaan Mufti.