A liquidity pool is a supply of cryptocurrencies or tokens locked in a smart contract in order to keep a decentralized exchange (DEX) liquid for trades to be executed. Liquidity pools allow users to pool their assets in a DEX’s smart contract to provide liquidity for traders to swap between currencies.
What is a liquidity pool on uniswap?
DAI/ETH is a good example of a popular liquidity pool on a DEX like Uniswap. A liquidity pool must be built in such a way that rewards crypto liquidity providers who stake their assets in a pool. Hence, most liquidity providers earn trading fees and crypto rewards from the DEXs they provide liquidity for.
How does liquidity work?
Based on the liquidity supplied to a pool, the liquidity provider (LP) receives special tokens called LP tokens in proportion to how much liquidity they supply to the pool. When the pool enables a sale, a 0.3 % cost is proportionally allocated to all LP token holders.
How do liquidity pools help a decentralized ecosystem?
Liquidity pools help a DeFi platform by providing liquidity, Liquidity pools help a decentralized ecosystem operate without an order book as it is in the case of centralized exchanges Liquidity pools are a very attractive means for HODLers to earn passive income However, we cannot ignore the possible risk exposure of liquidity pools.
