Liquidity pool
A liquidity pool is a smart contract that holds token reserves to enable automated market making (AMM) without order books.
Liquidity pools replace order books by letting users trade against token reserves priced by a formula. LPs deposit pairs of tokens and earn a share of fees proportional to their contribution.
"In a constant product AMM, x*y=k ensures liquidity at all prices, with slippage based on trade size relative to pool depth."
"LPs receive liquidity tokens representing their stake, redeemable for underlying assets plus accrued fees."
Risks include impermanent loss from price divergence, smart contract exploits, oracle manipulation, and MEV. Protocols mitigate via audits, bug bounties, and design improvements.
"Highly volatile pairs can cause significant impermanent loss for LPs during large price moves."
"Flash loans can amplify short-term price manipulations impacting pool health."
Related Terms
Decentralized Exchange
→A decentralized exchange (DEX) is a platform that allows users to trade digital assets directly with each other, without the need for an intermediary, such as a brokerage or bank.
Impermanent loss
→Impermanent loss is the loss LPs experience when providing liquidity to AMMs compared to holding assets, due to price divergence from the deposit ratio.
Fungible Token
→A token where each unit is interchangeable with any other unit of the same type, like currency.
Front-Running
→Executing a trade or transaction in anticipation of a known pending order to gain advantage; in crypto, often via observing the public mempool.
Flash Loan
→An uncollateralized on-chain loan that must be borrowed and repaid within a single transaction, enabled by composable DeFi.
All terms and definitions may update as the Cryptionary improves.
