Liquidity pools are collection of crypto assets present on the decentralized exchanges to facilitate trading. These are pools of tokens locked with the help of smart contracts, providing liquidity to the decentralized exchanges for smooth trading of pairs.
Decentralized exchanges are the ones that make use of liquidity pools along with automated market makers. The traditional order book is replaced with pre-funded liquidity pools on such platforms for trading assets. The main benefit of using a liquidity pool is that it neither requires a buyer nor a seller to decide the price for which the two assets shall be exchanged. This lets trades take place even with limited slippage. Trading pairs that are illiquid can easily be exchanged as long as there is a big liquidity pool. The funds present in such pools are provided by other users who also earn a passive income upon depositing their assets in the form of trading fees. Bancor was one of the first decentralized exchanges to provide such a system which was eventually adopted as well as popularized by Uniswap.