What is a liquidity pool?

A liquidity pool is a shared pot of two or more tokens locked in a smart contract so traders can swap between them without needing a matching buyer or seller. Instead of an order book, prices move based on a formula tied to how much of each token sits in the pool. This matters because it lets anyone trade or earn fees on decentralized exchanges like Uniswap, even for obscure tokens with few active traders. People who deposit tokens are called liquidity providers, and they earn a cut of trading fees in return. For example, a USDC/ETH pool on Uniswap might hold $2 million in each asset; every swap through it charges a small fee, often 0.3%, split among everyone who supplied funds. The main risk providers face is impermanent loss, when the price ratio between the two tokens shifts after depositing.