Term
Liquidity pool
A liquidity pool is a smart-contract-held pair (or set) of tokens that a decentralized exchange uses to price and settle trades — anyone can deposit tokens into the pool and earn a share of trading fees in return.
A liquidity pool is a smart contract holding a pair of tokens (say USDC and ETH) whose ratio determines the price a DEX quotes for trades between them. When you swap on a Uniswap-style AMM, you add to one side of the pool and remove from the other — the ratio shifts, and the next quote is worse for the same direction. This is the "price impact" of a large swap.
Anyone can become a liquidity provider (LP) by depositing an equal value of both tokens into the pool. In return, they receive LP tokens representing their share and earn a slice of trading fees paid by every swap through the pool. Popular DEXes have thousands of pools; smaller pools mean more slippage per trade but potentially higher fee yield.
LPing is not risk-free. The main risk is "impermanent loss" — when one side of the pair moves in price relative to the other, the LP ends up with a worse composition than they would have holding the tokens outside the pool.
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