Liquidity Pool is when money is deposited and locked up in Pools for the sake of earning reward and these rewards come from trading fees that happen in that pool.
How Does Liquidity Pools Work
When investors have their crypto assets in the liquidity pools they choose the assets they want depending with the Annual Percentage Yield being offered. There are a lot of liquidity providers you can chose from e.g Harvest Finance, Yearn.Finance e.t.c, you can see the number of assets and assets value locked up as this will help you in decision making when choosing.
What are Risks of Liquidity Pools
Everyone wants money but you should always consider the risks involved before you jump into the ship and do proper risks analysis so that you avoid disappointments. Liquidity Pools have risks of:
impermanent loss
Hacking
Rug pull
Impermanent Loss Lets say you chose your crypto asset that you want to invest in and then you deposit into the liquidity pool. Then it happens that the price of that asset changes drastically either up or down its called impermanent loss and then if you chose to withdraw your assets from the liquidity pool then that loss will become permanent.
Hacking Liquidity Pools are prone to hacking attacks and investors might lose their funds if the pool is infiltrated by hackers, e.g Harvest Finance was hacked in October 2020 and the hackers stole assets worth $24 million and this is a big risk with liquidity pools as you will lose you assets .
Rug Pull There are also chances that the admins behind the liquidity pool might varnish with investors money. After they see that they have enough to squander they will shut down the website like what happened with Defi100. So you should lock up what you are capable of losing and not to put all you eggs in one basket.
Liquidity pools are lucrative but proper analysis has to be done so that you won't lose money and also make sure you chose assets with no impermanent loss so that you avoid losses.
