Every time you swap on Base, a pool of tokens sits on the other side of the trade. Our guide on how a token swap actually works covers the formula that pool uses to price your trade. This one covers a different question: where does the pool's money come from, and what is it like to be the person who put it there.
The short answer is that ordinary users fund these pools, in exchange for a cut of every trading fee. It sounds like free money. It is not. The tradeoff is a real risk called impermanent loss, and understanding it is useful even if you never plan to provide liquidity yourself. It explains why some pools stay thin, why some tokens trade at oddly wide prices, and why "just earn fees by depositing two tokens" is not the easy yield it first appears to be.
Who funds a liquidity pool
A liquidity pool is a smart contract holding a reserve of two tokens, say ETH and USDC. Someone has to put those tokens there in the first place. That someone is called a liquidity provider, or LP.
Becoming an LP is simple in mechanics: you deposit a matched value of both tokens into the pool, and the contract issues you a receipt representing your share. From then on, every trader who swaps through that pool pays a small fee, split among the LPs in proportion to their share. Withdraw later and you redeem your share of whatever the pool holds at that moment, plus the fees it collected along the way.
On Base, this pattern shows up across decentralized exchanges such as Uniswap and Aerodrome, both of which run pools open to anyone willing to deposit. Nothing about becoming an LP requires permission. It is open to any wallet holding the right tokens.
Why the fees are not the whole story
If liquidity providing were just "deposit tokens, collect fees," it would be one of the safest ways to earn on-chain. The complication is that your two-token deposit does not sit still. As traders swap through the pool, the ratio of the two tokens you hold shifts, because that is literally how the pool prices trades. Buy pressure on one token pulls more of it out of the pool and leaves more of the other behind, whether you want it to be or not. You do not choose when to sell into strength, the pool's formula does it for you automatically. That automatic rebalancing is the source of impermanent loss.
What impermanent loss actually is
Impermanent loss is the gap between what your liquidity position is worth and what the same two tokens would be worth if you had simply held them in your wallet instead of depositing them.
Here is the mechanism. Say you deposit equal value of ETH and USDC into a pool. If ETH's price rises after that, traders will buy ETH out of the pool using USDC, since that is now the better deal by the pool's formula. As they do, your share of the pool ends up holding less ETH and more USDC than when you started, as if you had been selling ETH into the rally a little at a time without deciding to. If ETH's price falls instead, the reverse happens: you end up holding more ETH and less USDC, effectively buying the falling asset.
Either way, whichever token moved in price, you end up holding less of the one that helped you and more of the one that did not. Compared to just holding both tokens untouched, you come out behind. That gap is impermanent loss, and it grows with the size of the price move: a price ratio that doubles between the two tokens costs an LP roughly 5.7% versus simply holding, and larger swings cost proportionally more. This is a property of the constant product formula itself, not a fee being skimmed by anyone.
Why it is called "impermanent"
The name comes from the fact that the loss is only locked in when you withdraw. If the price ratio between the two tokens later returns to where it was when you deposited, the gap closes and the loss disappears, as if it never happened.
In practice, prices rarely retrace to the exact ratio they started at, especially over any meaningful stretch of time. An LP who withdraws while the ratio is still shifted away from their entry point realizes the loss for real. Treating "impermanent" as a promise that the loss will reverse on its own is the most common mistake newer liquidity providers make.
Why LPs do it anyway
Trading fees exist to offset exactly this risk. A pool with high volume relative to its size can generate enough fees to outweigh the impermanent loss from normal price movement, leaving the LP ahead overall. This is why liquidity concentrates in pools pairing assets that rarely move much against each other, such as two dollar-pegged stablecoins, where impermanent loss stays minimal because the price ratio barely changes. Pools pairing a stable asset with a volatile one need a higher fee tier or higher volume to be worthwhile, since the potential loss is larger.
What this means if you only ever swap
Simple Base Swap is built for trading tokens, not for managing liquidity positions, so none of this requires action from you as a swapper. But understanding it explains a few things you will notice while using any DEX on Base:
- A pool with thin liquidity often stays thin because the tokens involved are volatile enough that impermanent loss outweighs the fees on offer for most LPs. That thinness is part of why swapping an obscure token can carry a wider price than swapping a well established one.
- Stablecoin-to-stablecoin pools tend to be among the deepest and most reliably priced, precisely because impermanent loss to their LPs stays low.
- If a project advertises an unusually high yield for depositing liquidity, fee income alone is rarely the explanation. The volume may be genuinely exceptional, the yield may be subsidized by an inflating reward token, or the pairing may carry enough impermanent loss risk to make the real return far lower than the headline number.
None of this is investment advice, and providing liquidity is a separate activity from swapping with real tradeoffs of its own. But the next time you see a thin pool or a wide price on an unfamiliar token, you will know why: somewhere behind that pool is a liquidity provider weighing fee income against a real risk, and the market you are trading in is the result of that decision.