Liquidity pools run using AMM (Automated Market Makers). AMM is an algorithm that self-regulates the transaction and finalizes the contracts between the traders. (i.e. buyers and sellers.) Usually, when a transaction is made in a liquidity pool, AMMs use mathematical formulas to calculate how many assets they need to swap to complete the trade. This makes sure that no use of third parties is needed to regulate the system. These defi liquidity pools make use of both Smart contracts and Crypto technology to gain both liquidity and profit.
The users of the pool become Liquidity Providers (LP), by providing liquidity to the platform. The LPs deposit the assets and receive a share of the pool’s assets in return. These incentives or rewards are known as Liquidity Tokens. These earned Liquidity tokens have a value and can be used within the DEX’s ecosystem. These Liquidity Tokens signify that the value of the incentive earned is proportional to the value of assets contributed. The AMMs regulate the entire process and govern the system. Also, these AMMs ensure that the price doesn’t change much and maintain a fair market price.
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