Liquidity pools are a crypto industry concept. They give a lifeline to Defi protocol’s basic operations and function as hotbeds for investors with a passion for high risk and big profit. Liquidity pools are merely smart contracts that contain locked crypto tokens. The users of the platform provide these tokens. Liquidity pools provide asset liquidity and make it a smoother process for traders to swap currencies. They don’t need a third party to function; instead, they work independently.
Automated Market Makers:
The automated market makers (AMM) support them and keep the liquidity pools running and stable. Before they came into play, crypto market liquidity was an issue regarding Decentralized Crypto Exchanges and Ethereum. DEXs were new to the game, and it wasn’t yet widespread. It didn’t have a big enough audience; therefore, AMM was the solution. They provided more assets which brought with it high liquidity. The more assets included in a pool, the more liquidity is experienced in the pool. This makes trading and exchanging easier for all users.
When liquidity is low, it can lead to high slippage. Slippage is the expected price of a coin to what it sells for. Because few tokens are locked up in pools, token changes in a pool due to a swap or any other transaction produce a higher imbalance. On the other hand, traders won’t experience this when liquidity pools are high.
The slippage we spoke about beforehand is not the worst scenario. If the market has trouble providing enough liquidity for a particular trading pair, users will have tokens they can’t sell.
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What is Liquidity?(Opens in a new browser tab)