meaning of liquidity pool

A collection of cryptocurrency tokens or digital assets locked in a smart contract, typically on a decentralized exchange (DEX), which facilitates trading by providing liquidity to the market. These pools are fundamental to automated market makers (AMMs) and enable users to trade assets without traditional buyers and sellers, while also allowing liquidity providers to earn fees from trades.

Investors can earn passive income by contributing their cryptocurrency assets to a liquidity pool.

The decentralized exchange relies on various liquidity pools to ensure efficient trading pairs.

Etymology: The term 'liquidity' refers to the ease with which an asset can be converted into cash without affecting its market price, originating from financial markets. 'Pool' refers to a shared collection or aggregation of resources. In the context of cryptocurrency, the combination emerged with the rise of decentralized finance (DeFi) in the late 2010s, specifically to describe the aggregated assets used to facilitate trading on decentralized exchanges.

Cultural Notes: Liquidity pools are a cornerstone of the decentralized finance (DeFi) ecosystem, enabling peer-to-peer trading without intermediaries. They are closely associated with Automated Market Makers (AMMs) and allow for activities like yield farming and staking. While offering opportunities for passive income, participants in liquidity pools face risks such as 'impermanent loss,' which occurs when the price ratio of deposited assets changes significantly after deposit.

Word Frequency: common

Category: crypto

Language: English

Pronunciation: lɪˈkwɪdɪti puːl