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Accrue fee as Liquidity Provider (LP)
Liquidity pools are decentralized pools of tokens locked into a smart contract on a blockchain network. They are a core component of automated market makers (AMMs) used in decentralized exchanges (DEXs). Users can deposit their tokens to the pool and receive liquidity pool tokens representing their share in the pool, enabling them to participate in the trading activity on the DEX. The smart contract executes trades based on the tokens in the liquidity pool and an automated algorithm that adjusts the price of each token based on the relative supply and demand in the pool.
By pooling tokens together, liquidity providers earn fees from trading activity, while traders can benefit from deeper liquidity and better prices. Liquidity pools are critical infrastructure that enables decentralized trading and helps build a more open and transparent financial system.
Providing liquidity is not without risk, as you may be exposed to impermanent loss. It occurs when the value of two tokens in a liquidity pool becomes imbalanced due to market volatility. As a result, liquidity providers (LPs) can experience losses when traders buy one of the tokens and the pool sells the other to maintain balance. The LP's loss is temporary if the price eventually returns to its original value, but can be permanent if the price change is significant and long-lasting.