How Cardano's Liquidity Pools Work: A Guide for ADA Users

Cardano's decentralized exchanges (DEXs) rely on liquidity pools to facilitate trades. A pool is essentially a shared pot of tokens that supports trades on a DEX, and it holds two tokens with equal values.

The algorithm sets the price by balancing the two sides according to supply and demand. For example, if a pool holds Cardano's ADA (ADA) on one side and a stablecoin on the other, traders buying ADA from it will drive up its price within the pool.

Providers earn a share of the trading fees by depositing token pairs into DEX pools. However, several factors influence their earnings, including trading volume, the size of their deposit compared to the whole pool, and the fee rate set by the DEX.