The practise of one central bank lending liquidity to another by exchanging their respective currencies is where the phrase “liquidity swap” first appeared.
In this process, the lending central bank buys the borrowing central bank’s liquid currency at the current market exchange rate using its own liquid currency. The lender then consents to sell back the borrower’s currency, along with any interest earned on the loan, at a later date. The currency of the borrower serves as security for the loan.
In the world of cryptocurrencies, some exchanges may engage in liquidity swaps by exchanging their reserves of liquid stablecoins from other exchanges for their reserves of stablecoins like USDT. The reserves of their own native token, such as Binance’s BNB, may also be exchanged for stablecoins or other coins offered by another exchange.
Users can also exchange stablecoins like USDT for other stablecoins like DAI to conduct liquidity swaps with one another. This kind of exchange might be driven by anticipations of various swings among the stablecoins or the requirement for a certain stablecoin for trading.