What is Liquidity pool?

A liquidity pool is a smart contract holding a pair of assets that traders can swap against. Liquidity providers deposit the two assets, receive a token or a position representing their share, and earn a portion of the fees on every trade the pool executes. The pool is the counterparty to every swap, which is what lets a decentralized exchange trade without an order book or a market maker on the other side.

A provider’s share is valued as the two assets it currently represents, and those proportions change with every trade. When one asset rises, the pool holds less of it and more of the other, which is the mechanism behind impermanent loss. Fee income offsets that; whether it offsets enough is the question every provider is actually answering when they deposit. The share is usually represented by an LP token or, for concentrated positions, by an NFT that encodes the range.

Pools differ in shape. Classic pools hold two assets in equal value; stable pools hold assets that should trade at par and use a flatter curve; concentrated pools let providers pick a price range; weighted pools hold several assets in fixed proportions. Each has its own fee tier, its own risk and its own way of reporting a position. Rewards paid in a protocol's own token on top of fees, often called liquidity mining, are income with their own price risk and belong in the accounting too.

A tracker that shows an LP token as a balance with a made-up price is not tracking the position. TrueHold reads liquidity positions by protocol, values the underlying assets, and counts them into the total next to spot holdings, lending balances and staked positions.

Pools are also where most on-chain scams live, because anyone can create one for any token and seed it with a little liquidity to make a price appear real. A pool with almost no depth is a price you cannot actually get.