Liquidity pool
A liquidity pool is a shared pot of tokens in a smart contract. A DEX swaps coins from it, and depositors earn a share of the fees. A formula, not an order book, sets the price.
How it works
On a regular exchange buyers and sellers meet in an order book. A decentralized exchange (DEX) uses a pool instead: for example, ETH and USDC held in one smart contract. You swap one token for the other directly with the pool, and a formula sets the price. In the simplest design the product of the two token amounts must stay constant (x × y = k).
People who deposit tokens are called liquidity providers (LPs). In return they get LP tokens, a receipt for their share of the pool, plus part of the fee on every swap, often 0.05% to 1% depending on the pool.
The main risks: impermanent loss, when the token prices drift apart and your share is worth less than simply holding the coins; bugs and hacks in smart contracts; and pools with scam tokens that the creator can drain. A small pool also means big slippage on a large swap.
You put ETH and a stablecoin of equal value into a pool. Other people swap tokens, and the fee is split among depositors.
You deposit 1 ETH and 3,000 USDC with ETH at $3,000, $6,000 in total. ETH rises to $6,000. Simply holding, you would have $9,000, while your pool share is worth about $8,485 before fees. That gap of roughly 5.7% is impermanent loss.
Do not enter a pool for a nice percentage without understanding the risk. Token prices can drift apart, and your share may end up worth less than if you had simply held the coins. Code bugs are a risk too. A high APR often comes from rewards in a token that is itself falling, so weigh the yield against the possible loss and check how much money is really in the pool.
Questions and answers
What is a liquidity pool in simple terms?
It is a shared stash of two or more tokens in a smart contract. People swap coins against it on a DEX, and those who deposited the tokens earn part of the fees.
Can you lose money in a liquidity pool?
Yes. You can lose through impermanent loss on a big price move, a hack or contract bug, and the tokens themselves falling. Fees do not always make up for it.
What is impermanent loss?
It is the gap between the value of your pool share and what the same coins would be worth if you had just held them. It grows as the two token prices drift apart and becomes permanent if you withdraw at that point.
Related terms
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Updated: 2026-10-19