What liquidity means in trading
Liquidity is the ability to buy or sell an asset quickly without significantly moving the price. A liquid market has lots of buyers and sellers. An illiquid market has few — so even a small trade can cause large price swings.
On a traditional exchange, liquidity comes from market makers — firms that place buy and sell orders at various prices. On a DEX, liquidity comes from regular users who deposit tokens into pools. These users are called liquidity providers (LPs).
How liquidity pools work
A liquidity pool is a smart contract that holds two tokens in a specific ratio. For example, an ETH/USDC pool might hold $5 million worth of ETH and $5 million worth of USDC.
When someone wants to swap ETH for USDC, they deposit ETH into the pool and withdraw USDC. The pool's ratio shifts, and the price adjusts accordingly. The AMM formula (x × y = k) ensures the pool is always tradeable, at any size — though large trades get worse prices due to slippage.
What LPs earn
Every trade in the pool generates a fee (typically 0.3% on Uniswap V2, variable on V3). That fee is distributed proportionally to all LPs based on their share of the pool.
If you provide 1% of the total liquidity, you earn 1% of the fees. On a pool that processes $10 million in daily volume at 0.3%, total daily fees are $30,000. Your 1% share earns you $300/day. Sounds great — but there's a catch.
The catch: impermanent loss
When token prices change after you deposit, the pool rebalances your position. If ETH doubles in price, the pool sells some of your ETH for USDC to maintain the ratio. You end up with more USDC and less ETH than you started with — and the total value of your LP position is less than if you'd simply held the tokens.
This is called impermanent loss. It's "impermanent" because it reverses if prices return to the original ratio — but in practice, they often don't. For volatile pairs, impermanent loss can easily exceed the fees earned.
When liquidity providing makes sense
- Stable pairs. USDC/USDT or DAI/USDC pools have minimal impermanent loss because both tokens track the dollar.
- Correlated pairs. Pairs where both tokens tend to move together (like ETH/stETH) reduce impermanent loss risk.
- High-volume pools. If the fees earned consistently exceed impermanent loss, LP is profitable even with price movements.
- With additional incentives. Many protocols offer token rewards on top of trading fees, which can offset IL.
The foundation matters
Liquidity providing requires you to understand trading pairs, price movements, and fee mechanics at a deep level. If you jump in without that foundation, impermanent loss will eat your capital before you realize what happened.
Korvex lets you build that foundation safely — practice trading pairs with demo money, understand how prices move, and learn the fee math. That knowledge transfers directly when you're ready to provide liquidity on a DEX.