What Are Liquidity Pools? (DeFi Explained for 2025)

Hey, it’s Lanzo 👋
If you’ve ever used a DeFi app like Uniswap, Raydium, or Curve, you’ve interacted with something called a liquidity pool — even if you didn’t realize it.
These pools are the engine that keeps decentralized finance running.

In this guide, you’ll learn:

• What liquidity pools actually are
• How they replace traditional order books
• How you can earn yield by providing liquidity
• What “impermanent loss” means (and how to avoid it)
• Examples of real pools on Uniswap, PancakeSwap & Raydium
• How to stay safe while farming yields in 2025

Let’s dive in 👇

What Are Liquidity Pools? 💧

A liquidity pool is a smart contract that holds two (or more) crypto assets — for example, ETH and USDC — so people can trade directly against the pool instead of using an order book.

Think of it like this:

Instead of waiting for a buyer or seller, you trade with the pool — and the pool uses math to set the price.

These pools are the backbone of Automated Market Makers (AMMs) like:

• Uniswap (Ethereum)
• PancakeSwap (BNB Chain)
• Raydium (Solana)
• Curve Finance (Stablecoins)
• Balancer (multi-asset pools)

Every trade adds or removes liquidity, and the smart contract adjusts prices automatically.

How Liquidity Pools Work ⚙️

Liquidity pools rely on a mathematical formula to keep prices balanced.

The most common is Uniswap’s constant product formula:

x × y = k
(where x and y are token reserves, and k is constant)

If you buy ETH from a ETH/USDC pool, you remove ETH and add USDC — changing the ratio.
The pool’s algorithm automatically increases ETH’s price to restore balance.

Example:

• Pool has 100 ETH and 200,000 USDC (price $2,000 per ETH).
• A trader buys 1 ETH → pool now has 99 ETH and 202,000 USDC → ETH price rises slightly.

It’s all done automatically — no order books, no brokers.

Why Provide Liquidity? 💰

Liquidity providers (LPs) deposit tokens into pools so others can trade.
In return, LPs earn:

• Trading fees (e.g., 0.3% per swap on Uniswap)
• Yield farming rewards (extra tokens)
• Governance incentives (protocol tokens)

If a pool has $10M in liquidity and you contribute $100K, you own 1% of it.
Every time someone trades, you earn 1% of the collected fees.

This is how passive income in DeFi works — your money replaces traditional market makers.

Common Pool Types 🔄

Volatile pools offer higher fees but also higher risk, while stable pools are safer but earn less yield.

What Is Impermanent Loss? ⚠️

Impermanent loss happens when the price of one token changes relative to the other.
Your deposited assets become imbalanced, and when you withdraw, you might get less total value than if you’d just held both tokens.

Example:

• You deposit 1 ETH ($2,000) and 2,000 USDC.
• ETH price doubles to $4,000.
• The pool rebalances — now you own less ETH, more USDC.
• When you withdraw, your portfolio is worth less than simply HODLing.

That’s impermanent loss — “impermanent” because it disappears if prices return to original ratios.

Real Example: Uniswap ETH/USDC Pool 🧠

Let’s see how it looks in practice:

• Pool size: $250M
• Trading volume: $60M/day
• Fee: 0.3% per swap
• You deposit $10,000 (0.004% of the pool)

Your share of daily fees = 0.004% × $60M × 0.3% = $7.20/day
That’s about 26% annualized yield, assuming stable prices.

However, if ETH pumps 50%, impermanent loss may reduce that yield by ~5–8% — still profitable, but less than pure holding.

How Liquidity Pools Differ from Exchanges 🏦

Related: How to Connect Your Wallet to DeFi Apps

Where to Find the Best Pools 🌐

Top platforms in 2025:

• Uniswap v4 (Ethereum) — permissionless hooks, lower gas
• Curve Finance — best for stablecoin swaps
• Raydium (Solana) — low fees, high speed
• Balancer — weighted, multi-token pools
• PancakeSwap (BNB Chain) — high yield, community driven

If you’re new, start with stablecoin pairs — they’re easy to understand and carry minimal impermanent loss.

Security & Best Practices 🔒

1. Use hardware wallets for DeFi interactions (Ledger, NGRAVE).
2. Check audits before providing liquidity.
3. Avoid unknown pools — rugpulls still happen.
4. Understand token risks (depegs, volatility).
5. Track your rewards and claim them regularly.

Related: Social Engineering Attacks in Crypto (Explained)

Taxes & Tracking 📊

Every liquidity pool deposit and withdrawal counts as a taxable event in many countries.
Tracking this manually is painful — use portfolio tools that automatically sync with DeFi wallets.

Recommended tools:

• CoinLedger — imports on-chain LP data
• Zapper / DeBank — portfolio dashboards
• Ledger Live — overview of staking and DeFi assets

TL;DR 📌

• Liquidity pools power decentralized trading (AMMs).
• LPs earn fees + rewards for providing assets.
• Impermanent loss = price divergence risk.
• Stablecoin pools are safest for beginners.
• Use hardware wallets and track rewards with CoinLedger.
• DeFi = open markets, powered by code — not banks.

Start Earning Safely with DeFi 💸

⚠️ This post is for educational purposes only and does not constitute financial advice.
(This post contains affiliate links — supporting Lanzo at no extra cost to you.)