What is a liquidity pool?

A liquidity pool is a smart-contract vault that holds pairs of tokens and enables users to swap between them instantly without relying on order books. Liquidity providers deposit equal values of two tokens into the pool, and in return they receive LP tokens representing their share. These deposits allow users to execute swaps at any time, with prices determined automatically by the pool’s algorithm. As swaps happen, a small fee is charged and distributed proportionally to liquidity providers as income. Because the system is decentralized, anyone can add liquidity and earn a share of the swapping fees. Pools grow or shrink based on user deposits and withdrawals, directly influencing pricing and slippage.

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