Overview
A liquidity pool is a collection of cryptocurrency funds locked in a smart contract, used to facilitate decentralized trading and earn fees. Instead of matching buyers and sellers directly, automated market makers swap against these pools, so trades can happen at any time as long as the pool has both assets. Pool contributors, called liquidity providers, earn a share of trading fees in return.
How It Works
A liquidity provider deposits two assets in a ratio determined by current prices, receiving pool tokens that represent their share. When someone trades, the pool's balances shift and the trade executes at a price derived from the ratio, which is why larger trades cause more slippage. Fees accumulate in the pool and are distributed to providers proportionally to their share.
Why It Matters
Pools are the liquidity backbone of decentralized finance: they price swaps, support lending markets, and enable yield strategies. Anyone can become a market maker, which democratizes liquidity provision but also exposes providers to risks, most notably impermanent loss when the price of the deposited assets diverges from the deposit ratio.
Related Concepts
Liquidity pools power Automated Market Makers and DEXs. Providers must weigh Trading Fees against Impermanent Loss, and the pool's total deposits are measured by TVL.