Instead of matching buyers with sellers, a pool holds a reserve of both assets and quotes a price from their ratio. A trader swapping into the pool adds one asset and removes the other, which shifts the ratio and therefore the price — larger trades move it further, which is where slippage on a DEX comes from.
The reserves come from liquidity providers who deposit both assets and receive a share of every trading fee in proportion to their stake. That fee income is the return, and it is set against impermanent loss, the shortfall that appears when the two assets diverge in price. A pool is profitable to provide to when fees outrun that divergence.
How do liquidity providers earn money?
Every swap pays a fee to the pool, distributed to depositors in proportion to their share. Some protocols add token incentives on top, which is what yield farming usually refers to.
Last updated October 17, 2026