What is a liquidity pool?
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A liquidity pool is a smart contract that holds reserves of two (or more) tokens and enables automated trading between them. Instead of matching buyers with sellers through an order book, a pool uses a mathematical formula to determine the exchange rate based on the ratio of its reserves.
How it replaces the order book
In traditional finance, trading relies on a central limit order book — a ledger of buy and sell orders organized by price. A trade executes when a buyer's bid meets a seller's ask.
Decentralized exchanges like CenturionDEX replace this with an automated market maker (AMM). The pool always stands ready to trade: anyone can swap against it at any time, and the price adjusts algorithmically as the reserve ratio changes. For details on the pricing formula, see How are token prices determined?.
Liquidity providers
Anyone can deposit tokens into a pool, becoming a liquidity provider (LP). In return, they receive:
- LP tokens (v2) or position NFTs (v3) representing their share of the pool.
- Swap fees proportional to their share, earned every time a trader swaps through the pool.
Providing liquidity is not risk-free. Providers are exposed to impermanent loss — a potential reduction in value relative to simply holding the tokens — whenever the price ratio shifts.
Why pool depth matters
A pool's depth (the total value of its reserves) directly affects price impact. Deep pools can absorb large trades with minimal price movement; shallow pools cannot. Before swapping, it is worth checking the pool's liquidity to avoid an unfavorable execution price.
Explore available pools and their liquidity on the CenturionDEX app.