What is a liquidity pool?

A liquidity pool is a smart contract  or dApp holding a shared set of funds (tokens) contributed by users. Liquidity pools are used in DeFi in a wide range of different products and services. Some examples of these include:

• Lending  - where users deposit funds into a liquidity pool in return for yield on lent assets. Aave is an example of a lending dApp.
• Yield Optimization - where users deposit funds into a liquidity pool, and that pool then re-invests those assets to generate yield. Yearn.finance is an example of a yield optimization dApp.
• Constant Function Market Maker based DEXes - where liquidity pools typically contain two assets that users may swap between, e.g., the eXRD and USDC liquidity pool on Uniswap.
• Collateralized Debt Positions (CDP) - where users deposit funds into a pool as collateral to mint a smaller amount of debt, often denominated as a stablecoin. MakerDAO is an example of a CDP dApp.

Further reading:

• What is DeFi?
• What are Smart Contracts?
• What is Impermanent Loss?
• What are AMMs  (Automated Market Maker) and CFMMs (Constant Function Market Maker)?
• What’s a DEX?