Liquidity pools, in their most basic form, are just groups of tokens or digital assets held together under a smart contract.
When discussing cryptocurrencies, the term “liquidity” refers to the ease with which one’s holdings can be converted into fiat currency or another asset.
On decentralised exchanges and other DeFi platforms, users transact with one another via liquidity pools rather than through centralised market makers.
Liquidity Pools: What Are They?
Liquidity pools are pools of cryptocurrency or tokens that are locked in a smart contract and used to facilitate trades between assets on a decentralised exchange (DEX).
In the present DeFi ecosystem, liquidity pools are the core technology. Liquidity pools are essential for many different types of blockchain applications, including yield farming, lend-borrow protocols, automated market makers (AMM), crafted resources, on-chain protection, blockchain games, and more.
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Why Do We Need Liquidity Pools?
Users of a DEX can pool their assets together using the DEX’s smart contracts to form liquidity pools, which provide access to liquid assets for foreign exchange dealers. Liquidity pools offer the DeFi ecosystem with the money, time, and ease of use it needs to thrive.
Automated Market Makers (AMM) eliminate the requirement for an order book in on-chain trading. The order book is a network of people who are eager to buy and sell assets to one another. Since no direct counterparty is required to execute trades in AMM, traders have access to token pairs that would otherwise be extremely illiquid on order book exchanges.
You don’t need a “counterparty” in the conventional sense while trading through an AMM. If you want to make a deal, you’ll have to use the money in the liquidity pool to back it. The presence of a seller is not necessary for the purchase to go through; rather, there need only be enough funds for the purchase.
Liquidity pools foundation
Liquidity pools are the foundation of yield farming (also known as liquidity mining), in which users deposit monies into a pool that is then utilised to produce yield.
Distribution of newly created tokens to the appropriate parties is a challenging issue for crypto initiatives. Yield farming is a popular technique for this, where tokens are automatically paid to users that deposit their tokens in a liquidity pool.
Each user receives a number of newly created tokens equal to their stake in the pool.
What Is Liquidity Pools In Crypto – Video Explaination
Source: Google Trend