What is a liquidity pool?

In traditional finance, liquidity is organized using a central limit order book where buyers and sellers create orders (trade) organized by price and demand.

The Uniswap Protocol takes a different approach, using an Automatic Market Maker (AMM) to replace the traditional order book method with a liquidity pool of two assets, where the price is determined by an AMM.

 

A liquidity pool is group of tokens that are locked in a smart contract and used for trading between assets on a decentralized exchange (DEX) like Uniswap.

These pooled tokens are provided by liquidity providers (LPs) who receive an LP token in exchange for providing liquidity.

The Uniswap Protocol AMM sets prices for liquidity pools using the mathematical formula x*y=k. Prices are determined by the amount of each token in a pool, with x and y representing the two tokens in a liquidity pool. You can read more about this here: How are prices determined?

 

It is important to evaluate the liquidity available in a pool before swapping. A pool with low liquidity will not give you an optimal price, and could potentially result in a loss.

To evaluate the liquidity available in a liquidity pool, visit https://info.uniswap.org/#/pools and search for the pool or token you would like to swap.

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