How Liquidity Pools Work: A Beginner’s Guide
How Liquidity Pools Work: A Beginner’s Guide! Liquidity pools are a fundamental building block of decentralized finance (DeFi) ecosystems. They enable automated trading, lending, and other financial services without relying on traditional intermediaries like banks or brokers. Here’s an in-depth look at how liquidity pools work and why they matter. What Are Liquidity Pools? Liquidity pools are smart contract-based reserves of tokens locked in a decentralized protocol. These pools are designed to facilitate trading, lending, and earning opportunities on decentralized exchanges (DEXs) and other DeFi platforms. In essence, a liquidity pool is a shared pot of assets contributed by users called “liquidity providers” (LPs). These assets are used to support transactions and provide liquidity to the market. How Do Liquidity Pools Work? 1. Token Pairs and Balancing These token pairs are balanced using an automated market maker (AMM) algorithm, like the constant product fo...