// GLOSSARY -- DEFI

What is Liquidity Pool?

1 min read Updated

A liquidity pool is a smart contract holding reserves of two or more tokens that enables decentralized trading — users trade against the pool rather than matching with individual counterparties.

WHY IT MATTERS

Liquidity pools are the foundation of AMM-based DEXs. Instead of finding a buyer for your ETH, you swap against a pool containing ETH and USDC. The pool's smart contract handles pricing based on the ratio of assets.

Pools are funded by liquidity providers (LPs) who deposit equal values of both tokens. In return, LPs receive trading fees (typically 0.3% per swap) proportional to their pool share.

Pool depth (total liquidity) determines price impact. Deep pools handle large trades with minimal slippage. Shallow pools see significant price movement from even small trades.

FREQUENTLY ASKED QUESTIONS

How do LPs earn?
From trading fees — a percentage of every swap goes to LPs proportional to their pool share. Some pools also offer liquidity mining rewards (additional token incentives).
What's the risk of providing liquidity?
Impermanent loss: if token prices diverge, you end up with less value than simply holding. Smart contract risk (bugs) and rug pulls (project drains the pool) are also concerns.
Can I create my own pool?
Yes. On Uniswap and most DEXs, anyone can create a pool for any token pair. You set the initial price by the ratio of tokens you deposit.

FURTHER READING

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