DeFi
Liquidity Pool
A smart contract holding equal values of two tokens that enable decentralized trading through automated market makers.
Last Updated
2026-03-19
What is Liquidity Pool?
A liquidity pool is a smart contract holding two tokens in equal value, enabling peer-to-contract trading without centralized order books.
The simplest example: an ETH/USDC pool holds 1000 ETH and $3,000,000 USDC.
How does Liquidity Pool work?
Liquidity pools work through:
- LPs deposit equal value of token A and token B.
- The contract mints LP tokens representing their share.
- Traders swap token A for token B against the pool.
- The pool maintains x*y=k (constant product formula).
- Traders pay fees (typically 0.25-1%).
- Fees accumulate in the pool, increasing LP value.
- LPs can withdraw anytime, receiving their share of both tokens plus accumulated fees. Pool ratios determine prices: if the pool has more token A, token A is cheaper.
Why does Liquidity Pool matter?
Liquidity pools enable decentralized trading by replacing centralized order books with automated pricing. This removes gatekeeping and censorship.
Key features of Liquidity Pool
- Smart contract holding two tokens
- Equal value requirement
- Trading enabled through constant product formula
- LP tokens represent ownership share
- Fees earned by liquidity providers
- Decentralized price discovery
Examples of Liquidity Pool
ETH/USDC pool on Uniswap. DAI/USDC stable pool on Curve.
LP deposits 1 ETH + $3000 USDC, earns 0.25% of all ETH/USDC swaps.
Pool with $100M TVL earns ~$200k daily in fees if volume is $80M.