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Liquidity Pools
The building blocks of DeFi
TL;DR
Deposit paired assets to facilitate trades and earn trading fees.

Intro

Liquidity pools are the warm beating heart of DeFi. They are fundamental to the construction of yield farms, FaaS and decentralized exchanges. Not only are they great tools for investors, they also provide a much needed service to protocols in DeFi, in generating liquid markets. Philosophically, it is a pretty beautiful embodiment of decentralized finance to put your assets to work on both sides of the market.

How they work

Liquidity pools exist to facilitate trades on decentralized exchanges. They do so by pairing two or more assets in a specific ratio to maintain a constant price point. Therefore, when someone wants to trade Token A for Token B, the DEX dips into the pool and deposits the Token A and pulls out the Token B.
The ratio between all the tokens is maintained by arbitrageurs (usually bots) who capitalize on minor price discrepancies.
DEXs acquire these deep pools of liquidity by rewarding depositors with the trading fees earned on swaps in their pools. They often also issue tokens as an additional incentive.
If you are looking for examples, head to Reaper.Farm. Most of our crypts run on LP tokens. Just click any crypts name and it will take you to the exchange to make that LP token!

How to participate

Users participate by first creating an LP token comprised of any two assets on a DEX like Spooky Swap or Spirit Swap.
Users then deposit those tokens into the corresponding pool. It's just that simple! Users then return periodically to the exchange to harvest their rewards.
However, clever users will take their LP token to Reaper Farm instead so that their rewards will be automatically harvested and compounded on their behalf. ;)
There are some downsides to LPs. Namely, impermanent loss. See the below article or visit learn.bytemasons.com for more details.