Understand AMMs, liquidity providers, and impermanent loss basics.
Definition
A liquidity pool holds tokens that traders swap against. Liquidity providers deposit assets and earn fees.
Why pools exist
Automated markets set prices using formulas rather than an order book. Pools enable trading even with fewer market makers.
How LPs earn
LPs earn a share of swap fees and sometimes extra incentives. Returns depend on volume and volatility.
Impermanent loss
If one token moves strongly relative to the other, the pool rebalances and you may end with less of the winning asset than simple holding. Fees can offset this, but not always.
Practical tip
Compare LP returns to holding the same assets. That is your real benchmark.
Warning
Pools can look stable until volatility spikes. Then impermanent loss becomes obvious.
Quick quiz
- What is a liquidity pool?
- How do LPs earn fees?
- What triggers impermanent loss?