Liquidity Pool
Liquidity Pools are the backbone of many decentralized exchanges (DEX).
Created to enable Decentralized Exchanges (DEXs) to compete with Central Exchanges.
A Liquidity Pool is a set of digital assets locked in smart contracts, providing the foundation to trading and lending on DEXs such as Uniswap.
These pools provides liquidity to DEXs and creates price levels that are not dependent on market forces; they also contain ERC-20 tokens.
Problem
A CEX Order Book is a collection of the recent open orders for a given market, which functions alongside the matching engine—a system that matches orders and is at the core of centralized exchanges.
This model facilitates effective exchange and allows for the creation of financial markets;
The problem is that DeFi trading entails executing on-chain trades without a centralized party to hold the funds.
This makes interaction with the order book expensive and more complicated to execute trades.
Solution
DEXs develop Automated Market Makers (AMMs) to enable allow digital assets to be traded in an automatic and permissionless manner through the use of liquidity pools.
Related to:
- Automated Market Makers
- Yield Farming
- Borrow-lending
- Blockchain gaming
Risks
- Impermanent Loss
- Rug Pulls