What is a liquidity pool?

A liquidity pool is a reserve of assets held in a smart contract to support transactions such as token swaps. An LP is a liquidity provider. In an automated market maker, pooled assets let a trade execute without waiting for a matching buy or sell order.

A deposit establishes a claim on a position. Uniswap v2 represents that claim with LP tokens; v3 uses a position NFT. The NFT records ownership rather than serving primarily as a collectible picture. Fee allocation depends on the protocol and active liquidity. A pool deposit is not a fixed-interest savings account.

Example

Suppose a hypothetical pool holds 100 units of token A and 10,000 units of token B. A provider adds 10 A and 1,000 B at the existing ratio. Ignoring fees and price movement, the new balances become 110 A and 11,000 B. The provider owns 10 / 110, or approximately 9.09% of this simple pool—not 10%. The denominator includes the new deposit.

Swaps can then change the reserve quantities. Withdrawing does not guarantee the original 10 A and 1,000 B back. Concentrated-liquidity pools need a different fee-share calculation: the position’s price range and competing active liquidity matter, so its share of all deposited dollars is insufficient.

The impermanent loss example calculates why a position can fall behind simply holding its tokens. For pool selection, ranges and withdrawals, see how to provide liquidity.