Liquidity pools are a type of crypto asset that is used to make it easier to trade different cryptocurrencies on decentralized exchanges.
A liquidity pool is a collection of tokens that are locked in a smart contract. This allows for liquidity to be provided on decentralized exchanges, which helps to mitigate the usual illiquidity problems with these types of exchanges. Additionally, a liquidity pool is also the name given to the collection of orders that create certain price points. If these points are reached, the asset in question will determine if it wants to move higher or lower.
The decentralized exchanges that use liquidity pools are the same ones that use automated market maker-based systems. On these trading platforms, the traditional order book is replaced by pre-funded on-chain liquidity pools for both the assets of the trading pair.
Liquidity pools allow for trades to happen without a buyer and seller agreeing on a price. This is done by using a liquidity pool that is pre-funded. This allows for trades to happen even if the trading pairs are very illiquid, as long as there is a big enough liquidity pool.
The liquidity pools are funded by other users who earn passive income on their deposits through trading fees. This allows the liquidity pools to grow and provide more opportunities for earning passive income.
One of the first decentralized exchanges to introduce a system like this was Bor, but it was widely adopted in the space after Uniswap popularized them.