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Liquidity Pool

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Table of contents
    1. 0.2. How It Works
    2. 0.4. Significance in Decentralized Finance

A Liquidity Pool is a collection of funds locked in a smart contract, used to facilitate trading on decentralized exchanges (DEXs). These pools allow users to trade assets without relying on a centralized order book.

How It Works

Liquidity providers contribute tokens to a liquidity pool in exchange for a share of transaction fees. When traders swap tokens, the liquidity pool ensures smooth transactions by offering the necessary funds for trades. This system eliminates the need for order matching, a feature central to traditional exchanges.

Significance in Decentralized Finance

Liquidity pools are crucial for decentralized finance (DeFi) ecosystems, as they enhance the efficiency of trades and minimize price slippage. By contributing to these pools, users can earn passive income through transaction fees.