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What is PancakeSwap?

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At the height of the first wave of NFT in 2021, Ethereum’s gas charges became sky-high. As more and more people entered the world of DeFi, Ethereum’s network became (again) saturated. In turn, for each transaction, merchants had to pay more money.

Fortunately, a Binance Smart Chain (BSC) alternative was ready to accommodate Ethereum’s traffic spillover. One of the biggest beneficiaries has been PancakeSwap, BSC’s most popular decentralized exchange (DEX), equivalent to Ethereum’s Uniswap.

So what is PancakeSwap, and can you use it as a form of passive income?

What makes a DEX different from a CEX?

Until a few years ago, there was no decentralized exchange or DEX. Whether one wanted to trade stocks, commodities or cryptocurrencies, one had to seek the services of a centralized exchange or CEX. Managed by regulated companies with deep pockets, CEXs provide the market with the liquidity it needs to operate.

Related: What Is a Decentralized Cryptocurrency Exchange (DEX)?

For example, if you wanted to buy Tesla stock (TSLA), the market would have to have a seller. However, what if, at this precise moment, there is no seller? This is where market makers (NYSE, Nasdaq or Citadel Securities) come in. These exchanges ensure market liquidity by acting as a buyer / seller whenever a transaction is initiated.

By covering requests (sell orders) and offers (buy orders), CEXs ensure optimal market flow. In turn, one of the ways they make money is by charging a nominal fee for the asset that is traded, whether it is sold or bought. The question then is how can DEXs provide the same function – market liquidity – without having a centralized operation with deep pockets to cover all ask / bid spreads?

Revolutionary invention of blockchain – AMM

As you may have noticed, not all blockchains are created equal. Cryptocurrencies like Dogecoin (DOGE) operate on a blockchain that has no other purpose than to provide transactions. However, Ethereum and Binance Smart Chain are generalist blockchains.

With smart contracts embedded in every data block, these blockchains can digitize and automatically run any activity that can be legally built. One of these activities is trading, covered by smart contracts called Automated Market Makers or AMMs.

AMMs ensure that DEXs perform as well as CEXs in providing market liquidity. The two key elements in achieving this are liquidity pools and liquidity providers. Let’s take a look at CrepeSwap to see how it would play out in action. Most importantly, how you could earn money through this mechanism.

AMM and sliding

Before we dive into how PancakeSwap works, there is another important question to understand. On a regular centralized exchange like Binance, traders rely on the company to cover token requests / offers. As with stocks and commodities, it is very important that an initiated trade is executed quickly.

Otherwise you get a slippage i.e. the change in the sell / buy price between the market order and its execution time. This price differential is called Slippage Tolerance, with the norm being around 0.5% on DEXs. The more liquidity providers there are on a DEX, the lower the Slip Tolerance will be.

The most common way to avoid slippage is to use limit orders. A limit order allows traders to have a maximum buy limit or a maximum sell limit. In other words, the market order will not execute until these conditions are met. This brings us to how PancakeSwap and other DEXs work.

PancakeSwap Yield Farming

Agriculture

As mentioned earlier, AMMs consist of liquidity pools and liquidity providers. Liquidity pools are smart contracts that contain a number of tokens in the form of pairs. Therefore, whenever a trader wants to trade tokens, he has to tap into a pool of liquidity.

For example, the pair of BUSD / WBNB tokens in a cash pool is used to trade stable BUSDs for wrapped BNB tokens and vice versa. WBNB is used for trading with altcoins, while BNB is the equivalent of ETH on Ethereum. In other words, a dApp built on Binance Smart Chain could use WBNB – a BEP-20 token – while the BNB token itself is BSC’s native cryptocurrency.

list of pancakeswap liquidity pools

For these decentralized token exchanges to work, there has to be an incentive for the liquidity providers. After all, they are the ones who put their crypto assets in cash pools. With PancakeSwap, liquidity pools are called Syrup pools, and the reward comes in the form of CAKE tokens.

Whenever other traders dip into your syrup pool, you earn CAKE, depending on how much crypto you have locked in. Currently, a CAKE is worth around $ 24.6, as expressed in BSC’s stablecoin, BUSD.

You can create a syrup pool with CAKE / BUSD or CAKE / BNB as token pairs. As you can see, this is what is meant by yield farming: you become a yield farmer when you provide liquidity to the crypto market.

Is PancakeSwap Worth It?

Pancake swap

Since the Federal Reserve (and other central banks around the world) indulge in unprecedented money printing, commercial banks are offering almost zero APY (Annual Percentage Return). For example, Chase Savings bank accounts offer an interest rate of 0.01% APY.

By contrast, providing liquidity through PancakeSwap is light years away.

The APY for staking in the CAKE syrup pool is around 175% on your locked cryptos. This is why PancakeSwap has exploded in popularity, only behind Ethereum’s Uniswap in terms of transaction volume.

As such, PancakeSwap is obviously an enticing investment opportunity compared to traditional banking, with one exception:impermanent loss. If the price of your tokens put into play changes from the moment you lock them in a syrup pool, you risk losing. However, trading fees can still compensate for this if the price change is not too severe.

Finally, PancakeSwap offers an additional offer in the form of a lottery. In exchange for a lottery ticket in the form of a CAKE token, users can win a large sum of CAKE. The winner’s ticket will need to match six numbers to win 40% of the prize pool, with each ticket having a 1 in 10 chance of matching the first number.

As you might expect, only the most disciplined users with a compound ticket technique would stand out from the losers. It goes without saying that becoming a farmer with regular returns comes with a lot less risk.


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