Note · 2026-11-06 · Refs: Uniswap v2 Core whitepaper, Uniswap developer docs, DefiLlama

A liquidity pool is a smart contract holding two or more tokens that other contracts and users can trade against. The pool is the inventory; the pricing rule (an automated market maker curve, in most cases) decides how much of one token comes out when another goes in. The people who supply the inventory are liquidity providers, and their claim on it is tracked with LP shares.

Lending markets also call their deposit contracts “pools,” and the accounting is similar. This note covers the DEX case.

Share accounting, step by step

Hypothetical numbers throughout.

A pool holds 1,000 TKN and 100,000 USDC, and 10,000 LP shares exist. Each share is a claim on 0.1 TKN and 10 USDC.

  1. Deposit. A new provider adds 100 TKN and 10,000 USDC, matching the 1:100 ratio. That is 10% of each reserve, so the contract mints 1,000 new shares. The provider now owns 1,000 of 11,000 shares, about 9.09%.
  2. Trading. Over the following weeks, swaps move the reserves to 900 TKN and 112,000 USDC, and accumulated fees in a v2-style pool stay inside those reserves.
  3. Withdrawal. The provider burns 1,000 shares and receives 9.09% of the current reserves: about 81.8 TKN and 10,182 USDC.

The provider got back fewer TKN and more USDC than deposited. That mix shift is not a fee or a theft; it is the curve working as designed while traders bought TKN from the pool. Whether the provider is better or worse off than if they had held the original tokens depends on the price change and on the fees collected. The comparison is worked through in impermanent loss.

The Uniswap v2 whitepaper notes one design choice here: the first depositor’s shares are set to the geometric mean of the amounts deposited, so a share’s value does not depend on the ratio at which the pool was seeded. It also burns a small minimum amount of the first shares to make share-price manipulation expensive.

Where LP returns come from

Three sources, in descending order of durability:

  • Swap fees. Paid by traders on every swap. Uniswap’s fee docs list a flat 0.30% on v2 pools (of which 0.25% goes to LPs since protocol fees were switched on after the December 2025 UNIfication proposal), standard v3 tiers of 0.05%, 0.30% and 1%, and arbitrary or dynamic fees in v4. Fees scale with volume, not with deposits, so more liquidity chasing the same volume dilutes each share’s fee income.
  • Incentive emissions. Protocols sometimes pay extra tokens to LPs to attract depth. This is a marketing cost paid in the protocol’s own token and usually stops or shrinks. See yield farming.
  • Underlying yield. If the pooled tokens themselves accrue value (a liquid staking token, for example), the pool carries that too.

Against these sit the costs: the arbitrage loss described above, gas to enter and exit, and for concentrated positions the time and gas spent repositioning a range.

Full-range vs concentrated positions

In a v2-style pool every LP is spread across all prices, so every share earns from every trade. Uniswap’s concentrated liquidity docs describe v3 and v4 positions as liquidity “allocated within a custom price range.” Inside the range, a position provides more depth per dollar and earns a larger share of fees. Outside it, the position earns nothing and holds 100% of whichever token the market sold into it. Concentrated positions are closer to an active market-making strategy than to a passive deposit.

Pool-level risk checks

Before treating a pool as a place to park capital, the questions that usually matter:

  • Both tokens are exposures. The pool holds both assets. If one depegs, gets exploited or has a hidden mint function, arbitrageurs swap it in for the healthy asset until the pool holds mostly the impaired one.
  • Who controls the pool contract? Standard factory pools are usually immutable. Custom pools, v4 hooks and vault wrappers may have owners who can change fees or logic. Uniswap’s hooks page describes hooks as external contracts that run at points in the swap and liquidity flow.
  • Depth and concentration. Thin pools are easy to move, which matters if another protocol uses the pool as a price source. If most of the liquidity belongs to one or two wallets, depth can disappear in one transaction.
  • LP-token reuse. LP tokens are often deposited elsewhere as collateral or into farms. Each extra layer adds a contract dependency.
  • Liquidity lock claims. New-token teams sometimes claim their LP tokens are “locked.” The lock is only as good as the locker contract and its expiry date, which can be read on-chain.

The broader framework is in the DeFi risk checklist.

Scale reference

DefiLlama’s protocol data on 2026-11-06 put the DEX category at roughly $12.6 billion in TVL, with Uniswap’s v2, v3 and v4 deployments together a little over $3.5 billion of that. Most of that capital sits in a small number of large pools; the long tail of pools holds very little.

Describing how pools work is not a recommendation to deposit in one.