Web3 & DApp Development Fundamentals · Lesson

Liquidity Pools

Providing liquidity.

Liquidity Pools is a free Web3 & DApp Development Fundamentals lesson on CoddyKit — lesson 3 of 4. You can read the complete lesson below for free — then practise it hands-on in the browser with a built-in code editor and a 24/7 AI tutor. It is part of the Web3 & DApp Development Fundamentals learning path, one of 4 lessons in the course, and your progress syncs across the web and the CoddyKit app.

What Is a Liquidity Pool?

A liquidity pool is the reserve of two (or more) tokens locked in an AMM smart contract that traders swap against.

Without liquidity there is nothing to trade against, so pools are the foundation of every DEX.

Liquidity Providers (LPs)

A liquidity provider deposits tokens into a pool to enable trading and earn a share of the fees.

Anyone can become an LP — you simply supply both tokens of the pair in the correct ratio.

Depositing in the Correct Ratio

You must add both tokens proportional to the current reserves so you do not shift the price.

If the pool is 1 ETH : 2000 USDC, you deposit in that same ratio.

Pool ratio: 1 ETH : 2000 USDC
To add liquidity with 5 ETH
-> you also add 10000 USDC

LP Tokens

In return for your deposit, the pool mints LP tokens representing your share of the reserves.

Burning your LP tokens later lets you withdraw your portion plus accrued fees.

mint LPtokens = pool.totalSupply *
    (deposited / reserves)
// LP tokens = proof of your share

Earning Trading Fees

Every swap pays a fee that stays in the pool. As fees accumulate, the value backing each LP token grows.

Your earnings are proportional to your share and the pool's trading volume.

Impermanent Loss

Impermanent loss is the opportunity cost an LP suffers when the two tokens diverge in price compared to simply holding them.

The AMM rebalances the pool as prices move, leaving you with more of the falling asset and less of the rising one.

Why It Is Called Impermanent

The loss is impermanent because it disappears if prices return to their original ratio. It only becomes real when you withdraw at a diverged price.

Fees earned can offset or exceed impermanent loss, which is why high-volume pools remain attractive.

Price diverges -> paper loss vs holding
Price returns  -> loss vanishes
Withdraw while diverged -> loss realized

Stable Pairs Have Less IL

Pools of similar assets (USDC/DAI) barely diverge in price, so impermanent loss is minimal.

This is why stablecoin pools on protocols like Curve are popular with conservative LPs.

Pool Depth and Slippage

The more liquidity a pool holds, the less each trade moves the price. Deep pools offer low slippage and attract more volume.

More volume means more fees, which attracts more liquidity — a reinforcing cycle.

Liquidity Mining Incentives

To bootstrap a new pool, protocols often offer liquidity mining: extra reward tokens on top of trading fees.

These incentives jump-start liquidity but can fade once rewards end, so LPs must weigh long-term viability.

Putting It Together

Liquidity pools let anyone supply token pairs, receive LP tokens, and earn fees. The trade-off is impermanent loss when prices diverge, partially offset by fees and incentives.

Next we build a simple swap to see the mechanics in code.

Quick Check

Test your liquidity pool knowledge.

Recap: Liquidity Pools

You learned that:

LPs deposit token pairs and receive LP tokens
They earn a share of trading fees
Impermanent loss arises when prices diverge
Deep pools mean low slippage; incentives bootstrap liquidity

Next: coding a basic swap.

Frequently asked questions

Is the “Liquidity Pools” lesson free?

Yes — the full text of “Liquidity Pools” is free to read here on the web, and the Web3 & DApp Development Fundamentals course includes 4 lessons in total. To practise it interactively (a built-in code editor and a 24/7 AI tutor) and unlock the rest of the Web3 & DApp Development Fundamentals course, upgrade to CoddyKit PRO.

What will I learn in “Liquidity Pools”?

Providing liquidity. You practise Web3 & DApp Development Fundamentals with hands-on code you run directly in the browser, and a 24/7 AI tutor answers your questions as you work through the lesson.

Do I need any experience to start Web3 & DApp Development Fundamentals?

No prior experience is required. Web3 & DApp Development Fundamentals on CoddyKit is structured for beginners through advanced learners; this is — lesson 3 of 4, so you can start here or from the beginning and move at your own pace.

How long does the “Liquidity Pools” lesson take?

Most CoddyKit lessons take about 5–10 minutes. Each one is bite-sized and interactive, so you make steady progress and pick up exactly where you left off across the web and the app.

Can I write and run code in this Web3 & DApp Development Fundamentals lesson?

Yes. Every Web3 & DApp Development Fundamentals lesson includes a built-in code editor, so you write and run real code right in your browser and get instant AI feedback — no local setup required.

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