Shared reserves of two (or more) tokens that let an AMM offer trades without a matching counterparty.
Deposit
A liquidity provider deposits equal value of two tokens into a pool.
Receive LP tokens
The pool issues LP tokens representing the provider's share of the pool.
Earn fees
Trading fees accumulate in the pool proportional to each provider's share.
Withdraw
The provider redeems LP tokens for their share of the pool's current balances, whatever they are at that time.
Liquidity is what lets an AMM function at all - without pooled funds, there would be nothing to trade against.
Because withdrawal returns whatever ratio the pool currently holds (not necessarily what was deposited), a provider's balance of each token changes as the price moves - the basis of impermanent loss.
Is providing liquidity risk-free?
No. Besides impermanent loss, pool contracts themselves carry smart-contract risk, and low-liquidity pools can have very high price impact for traders.
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