Liquidity pool
A liquidity pool is a reserve of two tokens held in a smart contract that a DEX swaps against. The price comes from the ratio between the assets rather than an order book, and ordinary users fund it in exchange for a share of the fees.
How it works
The contract keeps the product of the two token balances constant. Buying one takes it out and puts the other in; the ratio shifts, and that shift is the new price. The formula exists so that a trade needs no matching counterparty at that moment.
A liquidity provider deposits both assets in the current ratio and receives a token representing their share. Fees from every trade, usually 0.05–1%, are split among all share holders.
Pool depth decides what a large trade costs. In a million-dollar pool a thousand-dollar swap barely moves the rate; in a fifty-thousand-dollar pool the same thousand moves it by whole percent.
Impermanent loss
You deposit 1 ETH at $2,000 alongside 2,000 USDT. ETH then doubles to $4,000.
| If you had simply held | $6,000 |
| Value of the pool share | ≈ $5,657 |
| Difference | ≈ −$343 (−5.7%) |
The pool sold ETH all the way up, so your share holds less of it. Fees may or may not cover the gap. The loss is called impermanent only because it disappears if the price returns to where it started.
What to weigh
- Correlated pairs are saferA pool of two stablecoins has almost no impermanent loss: their prices do not diverge.
- Yield comes from volumeA high APR in a pool with no trades is a number from nowhere. Read the volume, not the promise.
- Rewards are often the project's own tokenIt falls in price precisely because it is being printed to pay you. Count the yield in what you will actually keep.
- Contract risk remainsThe money sits in code. A pool exploit is uninsured, and the attacker is the one who gets out first.