Overview
Liquidity pools are the core component of Decentralized Finance (DeFi). They replace the traditional 'order book' used by centralized exchanges with a pool of assets that users can trade against.
How it Works
- Liquidity Providers (LPs): Users deposit pairs of tokens (e.g., ETH and USDC) into the pool.
- Trading: When someone wants to swap ETH for USDC, they send ETH to the pool and receive USDC from it.
- Fees: LPs earn a portion of the transaction fees generated by the pool as a reward for providing their capital.
Importance
Liquidity pools enable 'permissionless' trading, meaning anyone can trade at any time without needing a specific buyer or seller on the other side.