A liquidity pool is a smart contract holding two tokens in equal value. Traders swap through it, paying a 0.01-1% fee. You earn a share of those fees by providing both tokens.
When traders buy ETH with USDC, they deposit USDC and withdraw ETH. The pool now has more USDC and less ETH, changing the token ratio and raising ETH's price in the pool.
You provided 1 ETH + 2000 USDC. ETH rises to $2,500. The pool rebalances itself, selling your ETH for more USDC. You end up holding more USDC but less ETH than if you'd HODL'd.
If you held: 1 ETH ($2,500) + 2000 USDC = $4,500 total. If you stayed in the pool: 0.67 ETH ($1,675) + 2,985 USDC = $4,660 total. Seems better? You miss the 1 ETH upside.
High-volume pools like ETH/USDC earn 0.5-2% daily in fees. If fees exceed impermanent loss, you profit. Low-volume pools? Impermanent loss eats your returns.
Provide liquidity in stable pairs (USDC/USDT, ETH/stETH) where prices stay correlated. Avoid volatile altcoin pools unless fees are exceptional (20%+ APY). Do the math first.
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