A liquidity pool is a collection of digital assets that allows for trading on a decentralized exchange (DEX). It is created when users deposit their assets into a smart contract, and it provides the liquidity that is necessary for DEXs to function.
When a trade is executed on a DEX, a mathematical formula is used to calculate how much of each asset in the pool needs to be swapped. By providing liquidity to a pool, users can earn a share of the fees generated from trading activity. In addition, liquidity pools can be used for yield farming, where users can earn additional rewards such as platform tokens by providing liquidity.
As a liquidity provider, it is important to be aware of security risks and impermanent loss (IL). To reduce the risk of a rug pull (funds stolen by the protocol team) or smart contract vulnerabilities, it is advisable to select reputable protocols that have been audited and are well-established. To minimize the risk of IL, which occurs when the market value of assets in a liquidity pool changes relative to one another, it is recommended to choose less volatile assets and token pairs that are highly correlated.
SushiSwap is a trusted and reliable protocol in the decentralized finance space, with its codes being extensively audited and tested. In the SushiSwap App, you can access a variety of liquidity pools under the ‘Explore’ tab. Additionally, some pools have farms attached to them which offer extra incentives.
If you are interested in learning more about how to provide liquidity on SushiSwap, be sure to check out our Sushi Academy article on the topic.
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