Liquidity pools refer to the collection of cryptocurrencies to facilitate easy trading or pairing crypto on a decentralized exchange. The pool of tokens is locked in a smart control to provide constant liquidity for decentralized exchanges. An example of liquidity pool is the Ethereum-based trading system, Bancor.
Liquidity pools do not require a buyer and a seller to decide to exchange two assets for a given price; it leverages a pre-funded liquidity pool. Hence, traders can trade even illiquid assets with limited slippage. Funds held in liquidity pools are provided by other users to earn passive income on their assets.