Let’s talk about liquidity pools, because they’re one of those DeFi terms that sounds complicated but really isn’t once you get the hang of it.
A liquidity pool is basically a pot of tokens that people can trade from. Instead of using a traditional exchange with buyers and sellers, a liquidity pool lets users swap tokens instantly. It’s all automated, and it runs on smart contracts: no middlemen, no waiting.
Here’s how it works: someone (maybe you!) puts two tokens of equal value into a pool, like AVAX and USDC. That pool is then used by others to trade between those two tokens. Every time a trade happens, the trader pays a small fee, and that fee gets shared with everyone who added their tokens to the pool. So if you’re providing liquidity, you’re also earning a little in return.
Prices inside the pool are set by a formula, NOT by people, and they change based on how much of each token is being bought or sold.
Now, there’s something called impermanent loss, which sounds scary but just means this: if the value of the tokens you put in changes a lot compared to each other, you might end up with less than you started with. It’s not always a loss, but it’s something to be aware of.
Liquidity pools are part of what makes decentralized finance actually work. They’re a big part of how people can trade, without traditional banks or brokers.