How Do Liquidity Pools in DEXs Work?
Liquidity pools are pools of tokens locked in a smart contract on a decentralized exchange. Users, called liquidity providers (LPs), supply an equal value of two tokens to a pool.
In return, they receive LP tokens representing their share of the pool. Traders can then swap tokens using this pool, with the price determined by the AMM formula.
LPs earn trading fees from the swaps that occur in their pool, incentivizing them to provide liquidity.
Glossar
LP Tokens
Token ⎊ Liquidity Provider tokens, frequently denoted as LP Tokens, represent a user's share of a liquidity pool within decentralized exchanges (DEXs) or other DeFi protocols.
Liquidity Pools
Mechanism ⎊ Liquidity pools represent a fundamental shift in market microstructure, functioning as decentralized exchange (DEX) components that facilitate trading via automated market makers (AMMs).
Trading Fees
Cost ⎊ Trading fees represent a quantifiable deduction from capital employed in executing strategies across cryptocurrency, options, and derivative markets, directly impacting net profitability and risk-adjusted returns.
Yield Farming
Incentive ⎊ Yield farming represents a strategy within decentralized finance (DeFi) where users provide liquidity to various protocols, earning rewards typically in the form of governance tokens or a share of transaction fees.
Liquidity Providers
Capital ⎊ These entities supply the necessary assets to decentralized exchanges or automated market makers to facilitate continuous trading in crypto derivatives and options.