What is Liquidity?

Liquidity, in its simplest form, is the availability of assets to be easily traded on a platform. In DEXs, liquidity is provided by users who deposit their tokens into pools, known as liquidity pools (LP). These pools enable other users to swap between tokens without relying on a traditional order book. More liquidity in a pool means better price stability and smaller price slippage for trades..

Importance of Liquidity in DEXs

In a decentralized exchange, liquidity is crucial because:

• Smooth Trading Experience: Without sufficient liquidity, token swaps can be slow, and users may face high slippage, meaning they receive less value than expected from their trades.

• Price Stability: High liquidity ensures that large trades do not cause drastic changes in token prices. This is vital for maintaining market stability.

• Profit Opportunities for Liquidity Providers: By contributing liquidity, users can earn fees from trades that occur within the pool, creating an incentive for more people to provide liquidity.

Purpose of This Doc

This project aims to provide a simple yet comprehensive understanding of liquidity management. It will cover the fundamental concepts of DEXs, including how liquidity works in Version 2 and Version 3 exchanges. We will then explore how liquidity managers have evolved to tackle the challenges of providing liquidity, particularly in newer versions of DEXs. Each section will be concise and presented with clear headers, ensuring readers can quickly grasp the key points.