Liquidity Pool
A smart contract holding paired tokens (like USDC/ETH) that enables trading on a decentralized exchange.
Liquidity pools replace the order book model used by traditional exchanges. Instead of matching buyers and sellers, DEXs use pools of tokens deposited by liquidity providers (LPs). When you swap USDC for ETH, you're trading against the pool, not another person.
LPs earn a share of trading fees in exchange for depositing their tokens. This is one way to earn yield on USDC. You deposit USDC and another token into a pool, and you earn a portion of every swap that uses that pool.
The risk for LPs is impermanent loss: if the price ratio of the two tokens changes significantly, you might have been better off just holding them. For stablecoin pairs (like USDC/USDT), impermanent loss is minimal since both tokens stay near $1.
Related Terms
DEX (Decentralized Exchange)
A cryptocurrency exchange that operates through smart contracts, allowing users to trade directly without an intermediary.
Impermanent Loss
The potential loss a liquidity provider faces when the price ratio of pooled tokens changes compared to simply holding them.
Yield
The return earned on deposited or lent cryptocurrency, expressed as an interest rate.
DeFi (Decentralized Finance)
Financial services built on blockchain smart contracts that operate without traditional intermediaries like banks.
Swap
Exchanging one cryptocurrency for another, typically done through a DEX or exchange.
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This definition is provided for educational purposes. USDC.org is an independent resource and is not affiliated with Circle Internet Financial.