What is Liquidity Pool?

A liquidity pool is a smart contract holding a reserve of tokens that a decentralized exchange trades against. Instead of matching buyers and sellers directly, the DEX prices swaps based on the pool’s balances. Users who deposit tokens into the pool, called liquidity providers, earn a share of the trading fees.

This matters because providing liquidity is a common way to earn in DeFi, and pool depth determines how much slippage traders face. Deep pools mean smoother trades; shallow pools mean big price swings.

Example: you deposit a pair of tokens into a pool; each time someone swaps using that pool, you earn a slice of the fee proportional to your share.

Safety note: providing liquidity carries impermanent loss, where price divergence between the paired tokens can leave you worse off than simply holding. Pools for new or unaudited tokens can also be rug-pulled, and depositing requires token approvals that must be granted carefully. Understand impermanent loss and vet the protocol before providing liquidity. Related terms include impermanent loss, yield farming, DEX, and slippage.