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Protocol Wealth

Education

How liquidity pools work

A liquidity pool is a shared pot of assets held by a smart contract. Some pools let traders swap one asset for another; others lend an asset to borrowers. This page walks through how each works, what can go wrong, and the rules Protocol Wealth applies before using one.

A pool that traders swap against

Two assets sit together in one smart contract. A trader puts in one asset and takes out the other. There is no order book: the pool sets the price by a formula, based on how much of each asset it holds.

The assets in the pool were supplied by liquidity providers. Each trade pays a small fee, and that fee is shared among the liquidity providers in proportion to what they supplied.

A trader swaps token A for token B against a two-asset pool; the trading fee is shared among liquidity providers.The trader gives token A to the pool and gets token B back. Liquidity providers supply A and B to the pool. A dashed line carries each trade's fee from the pool to the providers.TraderPoolABgives Agets BLiquidityproviderssupply A + BEach trade's fee is shared with the providersA trader swaps token A for token B against a two-asset pool; the trading fee is shared among liquidity providers.The trader gives token A to the pool and gets token B back. Liquidity providers supply A and B to the pool. A dashed line carries a share of each fee from the pool to the providers.Tradergives Agets BABPoolsupply A + Bshare ofeach feeLiquidity providers
NoticeThe trader deals with the pool, not with another person; the liquidity providers' share comes from the fee each trade pays.

Choosing a price range

In pools that use concentrated liquidity (Uniswap v3 and v4), a liquidity provider chooses a price range. While the market price is inside that range, the position is active and receives a share of trading fees.

When the price leaves the range, the position stops receiving fees, and it ends up holding only one of the two assets.

Price below the range

Not earning feesHolds only token A

Price inside the range

Earning feesHolds a mix of A and B

Price above the range

Not earning feesHolds only token B
NoticeThe range stays fixed while the price moves; only the middle panel, with the price inside the range, receives fees.

Impermanent loss

When the prices of the two assets move apart, the pool rebalances a provider into more of the asset that fell and less of the one that rose. The position can then be worth less than if the provider had simply held the two assets outside the pool. That shortfall is called impermanent loss; it becomes permanent if the provider withdraws while prices are apart.

Two bars after a price move: assets held outside the pool, and the same assets in the pool, which is shorter. Illustrative, not to scale.The bar labeled Held is taller than the bar labeled In the pool. A bracket marks the difference between them as the gap. No values are shown.Illustrative · not to scaleHeldIn the poolThegapsame starting assets, after a price move
NoticeThe gap between the two bars is impermanent loss; the bars show direction only, with no values, and are not to scale.

Providing liquidity carries risk, including impermanent loss, smart-contract failure and the possible loss of the entire position.

What Uniswap v4 adds: hooks

Uniswap v4 keeps all pools in a single contract and adds hooks: optional programs attached to a pool that run at set points, such as just before or just after a swap. A hook can adjust the fee, manage a position's range, or check that a wallet is on an approved list before it may trade. A pool with no hook works like concentrated liquidity in v3.

A hook is code, so it adds smart-contract risk, and a liquidity provider has to judge the hook and whoever operates it as well as the pool.

One trade's timeline: trade submitted, optional before-swap hook, swap, optional after-swap hook, settled.A horizontal line runs from Trade submitted, through Swap executes, to Settled. An optional before-swap hook, for example a wallet check, attaches before the swap; an optional after-swap hook, for example a fee adjustment, attaches after it.TradesubmittedSwap executesSettledBefore-swap hookoptional · e.g. check walletAfter-swap hookoptional · e.g. adjust feeOne trade's timeline: trade submitted, optional before-swap hook, swap, optional after-swap hook, settled.A vertical line runs from Trade submitted, through Swap executes, to Settled. An optional before-swap hook, for example a wallet check, attaches before the swap; an optional after-swap hook, for example a fee adjustment, attaches after it.Trade submittedBefore-swap hookoptional · e.g. check walletSwap executesAfter-swap hookoptional · e.g. adjust feeSettled
NoticeThe trade itself is unchanged; a hook is an optional checkpoint that a pool can plug in just before or just after the swap.

Uniswap Labs announced Permissioned Pools on Uniswap v4 (July 23, 2026), a hook standard for trading regulated assets in which the pool checks whether a wallet is approved before a swap or liquidity action, and the issuer keeps control of the approved list. Source: Uniswap Labs blog.

Lending pools are a different thing

Lending protocols such as Aave also call their contracts “liquidity pools”, which is the most common source of confusion. In a lending pool you supply one asset, and borrowers take it out against collateral worth more than the loan. Nobody trades against your deposit.

Trading pool

e.g. Uniswap
You supply
Two assets
Others
Swap one asset for the other
Providers receive
A share of trading fees
Your asset mix
Shifts as the price moves

Lending pool

e.g. Aave
You supply
One asset
Others
Borrow it against more collateral than the loan
Suppliers receive
Interest paid by borrowers, which floats with demand
Your asset mix
Does not change

Aave v4: one hub, many spokes

Aave announced that Aave v4 has been live on Ethereum mainnet since March 30, 2026. Source: Aave blog; also reported by The Block.

Suppliers deposit into a central liquidity hub, which extends a capped credit line to each of three spokes, where borrowers sit.An arrow runs from Suppliers into the Liquidity Hub. Three arrows run from the hub to three spokes, each labeled own rules, own cap.SuppliersdepositLiquidityHubcappedcredit lineSpokeown rules,own capSpokeown rules,own capSpokeown rules,own capSuppliers deposit into a central liquidity hub, which extends a capped credit line to each of three spokes, where borrowers sit.An arrow runs from Suppliers into the Liquidity Hub. Three arrows run from the hub to three spokes, each labeled own rules, own cap.SuppliersdepositLiquidityHubcapped credit lineSpokeown rules, own capSpokeown rules, own capSpokeown rules, own cap
NoticeA supplier's deposit sits in one hub that lends to several spokes, so the supplier is exposed to every spoke the hub serves, up to each spoke's cap.

What can go wrong

Every pool is software holding assets, so the risks are real and some cannot be diversified away within a single pool. Five matter most.

Smart contract

A bug in the pool, or in a hook attached to it, can lose or lock the assets.

Depeg

A stablecoin or wrapped asset can stop tracking the asset it is meant to equal.

Range management

Out of range, a position receives no fees, and moving the range has costs of its own.

Liquidity

A thin pool can move sharply on one trade; a heavily borrowed lending pool can delay withdrawals.

Oracle and governance

A wrong price feed, or a governance change, can trigger losses or change a pool's rules.

NoticeThese risks stack: one position can carry all five at once, and none of them is removed by an audit or a permissioned design.

How Protocol Wealth uses pools

Pools are a tool we may use to carry out a strategy, not a product in their own right. Before we use a pool, it has to pass three gates.

A pool
Gate 1 · Size

At least $500,000 in the pool

Each pool needs at least $500,000 of pool-level TVL at the time we deploy into it.

Gate 2 · Source

Trading fees, counted separately from incentives

We distinguish trading fees paid by traders from incentive rewards a protocol hands out, and evaluate them separately.

Gate 3 · Assets

Approved assets only

Only assets in our research universe, or approved representations of them.

NoticeA pool must pass all three gates before we use it; passing them describes eligibility, not an expected result.

Important information

This page is educational and is not a recommendation to buy, sell or hold any asset or to use any protocol. It shows no performance, and nothing on it describes past or expected results. Figures are illustrative and not to scale.

Liquidity pools carry substantial risk, including smart-contract failure, depeg, impermanent loss, illiquidity, oracle and governance risk, and the possible loss of the entire amount deposited.

References to third-party protocols and firms do not imply affiliation or endorsement.

Information as of October 8, 2026.

For more about our services, fees and risks, see our Form ADV Part 2A.