Ever wondered how DeFi swaps happen with no order book and no middleman? It all comes down to liquidity pools.
A liquidity pool is a smart contract holding two tokens — say ETH and USDC. When you swap, you trade directly against that pool, and a simple formula adjusts the price based on supply and demand.
People who deposit tokens into these pools are called liquidity providers (LPs). In return for locking up their funds, they earn a share of every swap fee the pool generates 💧
More trading volume = more fees for LPs. But there is a catch: impermanent loss. When the price ratio between the two tokens shifts significantly, LPs can end up with less value than if they had simply held the tokens outright 🔄
Understanding pool fee structure and token volatility is essential before you become a liquidity provider.
A liquidity pool is a smart contract holding two tokens — say ETH and USDC. When you swap, you trade directly against that pool, and a simple formula adjusts the price based on supply and demand.
People who deposit tokens into these pools are called liquidity providers (LPs). In return for locking up their funds, they earn a share of every swap fee the pool generates 💧
More trading volume = more fees for LPs. But there is a catch: impermanent loss. When the price ratio between the two tokens shifts significantly, LPs can end up with less value than if they had simply held the tokens outright 🔄
Understanding pool fee structure and token volatility is essential before you become a liquidity provider.