Decentralized liquidity pools enable trading of tokens and are a fundamental money lego enabling open blockchain markets. Anyone can provide liquidity and you have self-custody over the funds. Note that liquidity pools with volatile tokens can incur impermanent loss (or divergence loss) as the asset values move apart.
Liquidity pools are on-chain contracts that provide a "place" to securely pool tokens (which can be called liquidity) so that users can use them to make trades in a decentralized way. The weighting of tokens in the pool determines the price for swapping between the tokens. Curve takes its name from elegant curve mathematics which allow for highly efficient swaps despite large imbalances in the pools.
These pools are created by users and decentralized apps (or Dapps, for short) who want to enable new token markets and profit from their usage. To pool liquidity, the amount a user supplies must be equally divided between two coins: the primary token (sometimes called the quote token) and the base token (usually ETH or a stable coin).
Curve's, Balancer's and Velodrome's liquidity pools all allow anyone to provide liquidity. Upon doing so, they will receive LP tokens (Liquidity Provider tokens). If a user deposits $INV and $ETH into a pool, they would receive INV-ETH LP tokens. These tokens represent a proportional share of the pooled assets, allowing a user to reclaim their funds at any point.
Every time another user uses the pool to trade between $INV and $ETH, a fee is taken on the trade which goes back to the LP pool.
The value of the SLP tokens is updated with each trade and the price for swapping the tokens is set by the weighting of the balance between the tokens in the pool. For example:
If previously there were 100 SLP tokens representing 100 ETH and 100 INV, each token would be worth 1 ETH & 1 INV (note in this example, ETH and INV are the same relative value). If a user were to trade 10 ETH for 10 INV in that pool, and another user were to trade 10 INV for 10 ETH, then there would now be 100.025 ETH and 100.025 INV. This means each LP token would be worth 1.0025 ETH and 1.00025 INV when it is withdrawn.
Deep liquidity pools for DOLA and INV is of great importance and Inverse Finance endeavors to secure permanent protocol owned liquidity (PoL) by periodically issuing INV bonds. These bonds act as a form of decentralized OTC where anyone can express their confidence in INV and be rewarded with a discount for exchanging LP tokens and other assets for INV bonds. Click the link below for more information: