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Author: Admin | 2025-04-28
DeFi instruments are often described as legos because of the way they can be used in combination with each other to create innovative solutions. Projects can build user incentives right into their code, so that all participants can benefit from helping to sustain the ecosystem. Liquidity pools are a great example of this type of relationship: liquidity providers get rewards for helping exchanges stay liquid, which in turn makes swap rates less volatile for exchange users.MEW’s partnership with DEX aggregator 1inch allows our users to get the best rates for token swaps right in their wallet. The team at 1inch are experts on liquidity questions, so we asked them to explain the concept to our community!Over the past year or so, liquidity pools have become a popular way of earning rewards in the DeFi space, attracting an increasing number of users. In this article, we’ll discuss how liquidity pools work, what earning opportunities they present and what possible risks should be taken into account.What is liquidity?Basically, the term ‘liquidity’ in crypto indicates how easy it is to swap one asset for another or convert a crypto asset into fiat money. Liquidity is a crucial factor for all operations in DeFi, such as token swaps, lending or borrowing.Low liquidity levels for a specific token lead to volatility, prompting severe fluctuations in that crypto’s swap rates. Conversely, high liquidity means that heavy price swings for a token are less likely.What is a liquidity pool?Liquidity pools occupy a large and important space in the DeFi ecosystem. A liquidity pool is basically a reserve of a cryptocurrency locked in a smart contract and used for crypto exchanges. Each liquidity pool consists of two tokens, that’s why liquidity pools are also referred to as pairs.One of the liquidity pools’ most popular uses are decentralized exchanges operating on the automated market maker (AMM) model. As opposed to traditional, order-book exchanges, on AMM-based DEXes, users trade crypto with smart contracts rather than with each other, and rates are based on mathematical formulas.Say, a user wants to swap token A for token B on an AMM-based DEX. So, the user goes to the DEX's A-B liquidity pool, deposits the amount of A they want to swap and receives in exchange an amount of B determined by the smart contract.But, for users to be able to swap any amount of A or B at any time, the pool has
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