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Liquidity Pool

A liquidity pool is a collection of funds locked into a smart contract within a decentralized exchange (DEX) or other DeFi platform, used to facilitate trading by providing liquidity. In liquidity pools, users (liquidity providers) contribute equal values of two different assets (e.g., ETH and USDT), which are used to enable decentralized trading without relying on traditional order books. In return, liquidity providers earn fees based on the trades that take place using the pool.

Example

An investor deposits an equal amount of Ethereum (ETH) and Tether (USDT) into a liquidity pool on a decentralized exchange to facilitate trading and earns a portion of the trading fees as a reward.

Key points

• A collection of funds used to facilitate decentralized trading on platforms like DEXs.

• Liquidity providers contribute assets and earn fees from trades in the pool.

• Common in DeFi, enabling trading without traditional market makers or order books.

Quick Answers to Curious Questions

They provide liquidity by allowing users to trade assets without an order book, using a pool of funds supplied by liquidity providers.

Users contribute assets to earn fees from trading activities that occur within the pool.

Liquidity providers face risks such as impermanent loss, where the value of their pooled assets may fluctuate due to price volatility.
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