What is Liquidity Pool?
Last reviewed 2026-05-03
A liquidity pool is a smart-contract-held reserve of two or more tokens that enables AMM trading. LPs deposit pairs in correct ratio, earn fees, and bear impermanent loss / LVR risk. Pools are the atomic unit of DEX liquidity.
How it works
An LP deposits two (or more) tokens into the pool contract at the pool's current ratio and receives LP tokens recording a pro-rata claim on the reserves. The contract enforces a pricing invariant — for constant-product pools, reserveA × reserveB = k — so the token balances alone define the price.
When a trader sends in token A, the contract computes how much token B to return by keeping the invariant satisfied after deducting the swap fee (commonly 0.01%–1%). The fee stays in the pool, so reserves grow slightly with every trade and LP tokens redeem for more over time. Larger trades move the price further along the curve — that gap is slippage.
The pool never consults an external price feed. Arbitrageurs trade against it whenever its implied price drifts from other venues, resetting reserves to the market rate; that rebalancing is what creates impermanent loss (LVR) for LPs. To exit, an LP burns their LP tokens and withdraws their share of both assets at the current ratio, not the deposit ratio. Concentrated-liquidity designs (Uniswap v3-style) let LPs commit capital to a chosen price range instead of the full curve.
Why it matters
Pools are the atomic unit of permissionless trading. Without them, on-chain DEXs would not work — order books on every chain are too slow/expensive.
Real-world examples
Uniswap v3 ETH/USDC 0.05% pool, Curve 3pool (USDC/USDT/DAI), Balancer 80/20 weighted pools, Aerodrome AERO/USDC.
Related terms
- AMM (Automated Market Maker)
- CPMM (Constant Product Market Maker)
- CLMM (Concentrated Liquidity Market Maker)
- Impermanent Loss (IL)
- LP Token
Go deeper
Browse the complete crypto glossary to explore related terms and concepts.
Browse GlossaryFrequently asked questions
What is a liquidity pool in DeFi?
A liquidity pool is a smart-contract-held reserve of two or more tokens that enables AMM trading, where LPs deposit pairs in correct ratio, earn fees, and bear impermanent loss or LVR risk.
How does a liquidity pool determine token prices?
The pool enforces a pricing invariant, such as reserveA × reserveB = k for constant-product pools, so the token balances alone define the price without consulting an external price feed.
What is concentrated liquidity in a liquidity pool?
Concentrated-liquidity designs, like Uniswap v3-style, let LPs commit capital to a chosen price range instead of the full curve.