10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.

com

What are liquidity pools?

A liquidity pool is a collection of cryptocurrencies or digital assets that help facilitate more efficient
financial transactions such as swapping, lending, and earning yield. People who put their assets in liquidity
pools earn rewards on their deposits. These incentives via liquidity pools have helped drive liquidity to
decentralized applications (DApps
DApps), enabling many of them to start competing with their centralized
counterparts. As decentralized finance (DeFi) becomes more popular, it can scale to eventually
outcompete traditional centralized financial services.

Anyone can earn yield by depositing select cryptoassets into liquidity pools on Bitcoin.com’s multichain
Verse DEX.
DEX Check the rewards, measured in APY, available right now on Verse DEX pools here
here. Use Verse
DEX to safely and securely swap crypto with low fees, including cross-chain trading between BTC, BCH, ETH
and more.

Table of Contents

1. The importance of liquidity pools

2. How do liquidity pools work?
3. What are liquidity pools used for?
4. The benefits and risks of liquidity pools

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 1/8
10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.com

The importance of liquidity pools

The fundamental building block of any financial market is an exchange — a place where buyers and
sellers meet to make a market. In traditional finance this has always necessitated a trusted third party to
intermediate the trade. The crypto industry revolutionized this dynamic by removing the need of the
trusted middle man with the introduction of decentralized exchanges (DEXs). Unfortunately, DEXs (and
crypto in general) had a fatal liquidity problem.

Deep liquidity is one of the most important attributes for any financial market because it enables fast and
efficient financial transactions. Early DEXs were so illiquid as to be practically unusable. Liquidity pools
helped change this. Soon after the advent of liquidity pools, DEXs began to flourish and with them the
entire DeFi ecosystem exploded.

Liquidity pools are not only useful in DEXs. They add liquidity to almost every DApp in DeFi. Lending
protocols, yield farming, prediction markets, insurance, and more all use liquidity pools to make financial
actions smoother.

How do liquidity pools work?

There are two important considerations to how liquidity pools work: 1) the technical details of depositing
cryptoassets into a pool and 2) the psychological aspect of getting people to deposit their assets.

The technical details can vary from project to project, but generally follow the same pattern. A smart
contract accepts certain cryptoasset deposits. The restrictions of what is accepted and in what ratio may
differ. For example, most DEX liquidity pools represent trading pairs, which means depositing into the
pool requires an equal value amount of the two cryptoassets that make up the pair. The VERSE-WETH
pool requires VERSE and WETH in equal value based on the DEX’s current market price.

Upon depositing into the pool, funds may or may not be locked for a set period of time. The smart
contract mints and sends you a token that is a kind of receipt. This token is used to realize any
outstanding rewards from your position, and to withdraw your deposited cryptoassets. The ratio of the
returned cryptoassets might be different from when you started.

As for getting people to participate in liquidity pools, this has been an age old challenge. Traditional
financial institutions such as banks attract liquidity by giving rewards (interest) on deposits, although
interest rates on bank deposits have been quite low for a long time. Liquidity pools offer yield in the form
of fee sharing.

What are liquidity pools used for?

DEX: Most DEXs use an automatic market maker (AMM) model as opposed to centralized exchanges
which use an order book model. An order book matches buyers and sellers directly to each other. AMMs

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 2/8
10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.com

match buyers and sellers to a liquidity pool. Liquidity providers are paid a proportional share of the fees
generated when people trade the assets in a given liquidity pool.

Lending: In traditional finance, banks or other large financial institutions take people’s deposits, lend
them out, and collect interest from the loans. In DeFi, you deposit your assets into a liquidity pool and
people can borrow from the pool. Depositors earn a portion of the interest paid by borrowers. The
difference is that since banks are in a highly privileged position they take most of the interest earned from
loans, while the much more competitive DeFi protocols take a much smaller percentage.

Prediction market: People that add to a liquidity pool earn a percentage of each trade, proportionate to
their ownership of the liquidity pool. Prediction market liquidity pool positions need be entered and
exited carefully as they can be very volatile.

Insurance: People can deposit funds in a liquidity pool that will be used to pay out insurance claims in the
unfortunate case of negative events like loss of funds due to smart contract flaws or insolvent exchanges.
Liquidity providers earn a portion of the insurance fees.

The benefits and risks of liquidity pools

There are two main benefits to using liquidity pools, one financial and the other societal. The main
financial benefit is, of course, that you earn rewards by holding your cryptoassets in a liquidity pool. The
societal good is that liquidity providers help to create more economic freedom in the world. How? DeFi
needs liquidity. Making DeFi DApps more liquid makes DeFi more of a viable alternative to the centralized
financial system. A decentralized alternative to centralized finance brings more economic freedom to
everyone, but especially to developing markets or repressive regimes.

Depositing your cryptoassets into a liquidity pool comes with risks. The most common risks are from
DApp developers, smart contracts, and market volatility. DApp developers could steal deposited assets or
squander them. Smart contracts might have flaws or exploits that lock or allow funds to be stolen. Market
volatility can cause something called impermanent loss, which largely affects DEX liquidity pools.

The best way to mitigate yield farming risks is to research projects before you deposit anything, and to
stick with projects with a long track record.

Buy as little as $30 worth to get started

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 3/8
10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.com

Buy now

Choose from Bitcoin, Bitcoin Cash, Ethereum, and more

Related guides Start from here →

What is Verse?
Learn about Bitcoin.com’s official token, ways to earn it, and how to use it in
the Bitcoin.com ecosystem and beyond.

How do I buy VERSE?

Learn how to get Bitcoin.com’s ecosystem token VERSE in the Bitcoin.com
Wallet, via Bitcoin.com’s decentralized exchange Verse DEX, and more.

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 4/8
10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.com

How do I sell VERSE?

Learn how to trade Bitcoin.com’s ecosystem token VERSE in the Bitcoin.com
Wallet, via Bitcoin.com’s decentralized exchange Verse DEX, and more.

What is Verse DEX?

Learn about Bitcoin.com’s official decentralized exchange and how to use it to
trade and to earn.

What is a DEX?
A decentralized exchange (DEX) is a type of exchange that specializes in peer-
to-peer transactions of cryptocurrencies and digital assets. Unlike centralized
exchanges (CEXs), DEXs do not require a trusted third party, or intermediary,
to facilitate the exchange of cryptoassets.

What is Verse Community?

Learn how the Verse Community will support developers and participants
through initiatives, events, and projects that grow Bitcoin.com’s Verse
ecosystem.

What is yield farming?

Learn what yield farming is, how it works, different types, and more.

What is Ethereum?
Understand Ethereum's key characteristics.

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 5/8
10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.com

What is Avalanche?
Understand Avalanche's key characteristics.

What is Polygon?
Discover Polygon's (MATIC) key characteristics.

Bitcoin.com in your inbox

A weekly rundown of the news that matters, plus educational resources and updates on products &
services that support economic freedom

Sign up

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 6/8
10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.com

Over 43,679,000 wallets created so far

Start investing safely with the Bitcoin.com Wallet

Download now

English

© 2023 Saint Bitts LLC

Bitcoin.com
All rights reserved.

Company Products & Services

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 7/8
10/20/23, 1:41 AM What are liquidity pools? | Get Started with Bitcoin.com

About Learning Center

Advertise Wallet
Careers Verse DEX
Blog Developers
Contact Bitcoin Cash Register
Partners
Support Bitcoin Data
Legal
Block Explorer
Sitemap
Markets
Tools

Educate Follow

Bitcoin Whitepaper News

Learning Center Telegram
Satoshi's Archive YouTube
Instagram

Get Crypto Twitter

Facebook
Buy Verse
Buy Bitcoin
Buy Ethereum
Buy Bitcoin Cash
Buy USDT
Buy USDC
Buy Avalanche
Buy Polygon

Spend Crypto

Sell Bitcoin
Crypto Merchants
Bitcoin Map
Games
Bitcoin Casino

https://www.bitcoin.com/get-started/what-are-liquidity-pools/ 8/8