Liquidity pool
A liquidity pool is a smart contract into which users deposit two tokens so others can swap against them; depositors receive trading fees in return.
Explained simply
For a decentralised exchange to be tradable at all times it needs inventory. That is supplied by users who place two tokens of equal value into a pool, say Ether and a dollar stablecoin.
Every swap shifts the ratio in the pool and hence the price. Depositors receive a share of the trading fees. But they carry a risk: if prices move strongly, their share may be worth less than if they had simply held the tokens ("impermanent loss").
From the familiar world
A bureau de change operator always keeps a stock of euros and dollars and earns on the spread. The liquidity pool is that bureau, except many small investors jointly supply the stock and share the spread.
An example
An investor puts 1,000 euros in Ether and 1,000 euros in stablecoins into a pool. Over the year he collects fees, but because Ether rises sharply the pool ends up holding less Ether and more stablecoins than at the start.
Why it matters
Liquidity pools explain where the widely advertised "yields" in DeFi come from: trading fees, not thin air. And they explain the risk behind them.
To pass on
„A liquidity pool is a bureau de change whose stock many investors supply together. They earn the fees but carry price risk.“
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