Liquidity Pool

Liquidity pools are the engine that powers decentralized exchanges (DEXs) like Uniswap, SushiSwap, and Curve. Instead of matching buyers with sellers (like a traditional order book exchange), DEXs use pools of tokens that anyone can trade against. Liquidity providers (LPs) deposit tokens into these pools and earn a share of the trading fees.

A typical liquidity pool contains two tokens in equal value — for example, ETH and USDC. When someone swaps ETH for USDC, they're adding ETH to the pool and removing USDC. The automated market maker (AMM) algorithm adjusts the price based on the ratio of tokens in the pool, ensuring that the pool always has both tokens available.

Liquidity providers earn a percentage of every trade that occurs in their pool. On Uniswap V3, for example, LPs earn 0.01% to 1% of each trade's value (depending on the fee tier). The fees are distributed proportionally to each LP's share of the total pool liquidity.

The main risk for liquidity providers is impermanent loss — when the relative price of the two tokens changes, LPs may end up with less value than if they had simply held the tokens. This loss is "impermanent" because it reverses if prices return to their original ratio, but it becomes permanent if you withdraw while prices are divergent.

For portfolio tracking, LP positions represent a special type of holding: you own a share of a pool rather than specific token amounts. The value depends on both the pool's total value and the current token prices. Properly tracking LP positions requires understanding the pool mechanics and token ratios.