What Role Does Arbitrage Play in Maintaining the Price Correlation between Assets in a Liquidity Pool and the Broader Market?

Arbitrage is the key mechanism that keeps prices in a liquidity pool aligned with the broader market. When a token's price in the pool deviates from its price on external exchanges, arbitrageurs are incentivized to buy the asset where it is cheap and sell it where it is expensive.

This activity continues until the price difference is no longer profitable, effectively syncing the pool's price with the market price and ensuring the pool reflects the asset's true value.